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Loan Originator Compensation – It's Complicated

 

Loan Originator Compensation – It's Complicated

On January 18, 2013, the Consumer Financial Protection Bureau (the “Bureau”) issued its final loan originator compensation rule (the “Rule”). More than five years later, many financial institutions still find themselves struggling to understand what types of payments they can and cannot make to their loan originators because, well, it’s complicated. 

 

Among other things, the Rule restricts certain compensation paid to loan originators in connection with most closed-end dwelling-secured mortgage transactions (“covered transactions”). Specifically, the Rule prohibits loan originators from receiving, directly or indirectly, compensation in any amount that is based on a term of a transaction, the terms of multiple transactions by an individual loan originator, or a proxy for a term of a transaction. 

 

The purpose of the Rule is to prohibit incentives that could cause a loan originator to steer consumers into certain credit products or features in order to increase the loan originator’s own compensation, regardless of consumer harm.[1] 

 

Before we get started, let’s define a few key terms . . .

For this article, compensation includes salaries, commissions, bonuses, enhanced periodic payments (e.g., monthly, quarterly, or similar threshold-driven awards), awards of merchandise, services, trips, or similar prizes,[2] and awards of stock, stock options, or equity interests.[3] 

 

Terms of a transaction include any right or obligation of the parties to a credit transaction and any fees or charges on the Closing Disclosure that are imposed by the creditor for the credit or any credit-related product or service provided by the creditor or an affiliate, or for any product or service required as a condition of the credit. Examples of transaction terms include, but aren’t limited to, interest rate, annual percentage rate (APR), collateral type (e.g., condo, cooperative, detached home, or manufactured housing), lien status, prepayment penalty, origination points or fees paid, and fees for creditor-required title insurance. 

 

A proxy is considered to be a factor if it consistently varies with that term over a significant number of transactions, which then reflects a connection between the factor and the term, if the loan originator has the ability, directly or indirectly, to add, drop, or change the factor when originating the transaction.

 

Relevant time period refers to the time during which the compensation was earned, regardless of when it is paid.

 

What types of enhanced periodic payments are permissible?

In addition to or instead of a straight salary or hourly wage, the Rule permits a loan originator to receive a fixed payment that is determined in advance for every covered loan the originator arranges for the creditor. For example, $500 for every consummated covered transaction or $750 for the first 500 transactions and $1,000 for each additional transaction consummated during the relevant time period. 

 

The Rule also permits loan originators to receive payments based on the amount of credit extended as long as compensation is based on a fixed percentage of the amount of credit extended.[4] This fixed percentage CAN be subject to a minimum and/or maximum dollar amount, provided the minimum and maximum do not vary with each credit transaction and the percentage is based on the total amount of credit extended during the relevant time period. 

 

What payments are prohibited?

The Rule bans loan originator payments that may vary with mortgage-related profits. This means compensation cannot be based on profits that are calculated with reference to revenue generated from covered transactions, such as origination fees and interest associated with these transactions, proceeds of secondary market sales of such transactions, or income derived from the servicing of covered transactions. 

 

Are there any exceptions?

The Rule provides limited exception for certain deferred tax-advantaged plans allowing loan originators to receive compensation that qualifies for tax-advantaged status and is paid in the form of a defined contribution or defined benefit. Be aware, however, in the case of defined contribution plans, the amount of the contribution cannot be directly or indirectly based on the terms of an individual loan originator's transactions. 

 

There’s also an exception for non-deferred profits-based compensation plans if the payments are less than 10% of the total compensation paid during the relevant time period.  Examples of both are provided in the Calculating “Total Compensation” table below.

 

How is the 10% limit calculated?

To identify the amount of the 10% limit, we first have to calculate the amount of total compensation. This is done by adding up the total of all wages and tips that were paid during that time, regardless of when those amounts were earned. 

 

If the loan originator’s compensation is reportable on a W-2, use the amount reportable for Medicare tax purposes in box 5. If the loan originator is an independent contractor, use the amount of compensation reportable on IRS form 1099-MISC. For a loan originator who receives both W-2 and 1099-MISC income, add both amounts together. 

 

Here’s where it gets tricky.  At the payor’s option, total compensation may also include:

 

  • Contributions made during the relevant time period to any deferred tax-advantaged defined contribution plan.
  • Any non-deferred profits-based compensation such as bonus pools, profit pools, bonus plans, and profit-sharing plans earned during the relevant time period.

 

Calculating “Total Compensation”

Payment Type

Is it paid or earned during the relevant time period?

Is it mandatory or optional to include?

Wages & Tips

(from W-2 box 5 and/or 1099-MISC)

Count the amount paid during the period, regardless of when earned

Mandatory

Contributions to defined contribution deferred tax-advantaged plans

(401(k), 403(b), Simple IRA, employee pension plans, etc.)

Count the amount paid during the period, regardless of when earned

 

Optional

Certain non-deferred profits-based compensation

Count the amount earned during the period, regardless of when paid

Optional

 

When non-deferred profits-based compensation is not included in the calculation, simply take the amount of total compensation and multiply it by 0.10 to identify the 10% limit. 

 

It’s when non-deferred profits-based compensation earned during the relevant time period is included that there is a need to account for this amount in both the numerator and denominator of the total compensation calculation. 

 

Here’s an example. Let’s say the total compensation before payment of the non-deferred profits-based compensation plan is $175,000. To get the amount that can be paid without exceeding the 10% limit, take the base amount and always divide it by 9. Using 9 as the denominator ensures the amount of the non-deferred profits-based bonus, when added to the base amount, yields a total compensation for which the bonus is exactly 10%. Next, calculate the amount of total compensation by adding the result of the prior equation, in this case, $19,444, to the base amount, $175,000. So, for this example, $19,444 plus $175,000 is $194,444. The bonus payment of $19,444 is 10% of $194,444 and is within the limit of the Rule. 

 

$175,000 / 9 = $19,444

$175,000 + $19,444 = $194,444

194,444 X 10% = $19,444

 

Are there any exceptions to the 10% limit? 

You bet. Those individuals who only occasionally act as a loan originator and have done so for 10 or less covered transactions consummated during the 12-month period preceding the date of the compensation determination are not limited by the 10% cap.[5]

 

In addition, the restriction doesn’t apply to profits derived from business other than mortgage-related profits, as determined with reasonable accounting principles. Keep in mind, however, if mortgage-related and non-mortgage-related business profits are not separately calculated, the Bureau tells us all profits are to be regarded as being from mortgage-related business.

 

Are there any payment types that are not prohibited or restricted?

Of course. Just because a payment is labeled a bonus and is related to mortgage activity doesn’t in and of itself make it a bonus based on mortgage-related profits. The following payments are not prohibited:

 

  • A retention bonus budgeted for in advance, and
  • A performance bonus paid out of a bonus pool set aside at the beginning of the company’s annual accounting period as part of the company’s operating budget.[6]

 

This is true regardless of whether these payments are based on the terms of a transaction or transactions by that individual loan originator. The reason is that they were budgeted for in advance or set aside in advance, they are not considered to be based on the profits of a mortgage-related business, and are therefore not prohibited.[7]

 

What records must be maintained?

To prove compliance with the Rule, financial institutions are generally required to maintain sufficient records of all compensation paid to loan originators, along with loan originator compensation agreements, for three years after the date of payment. Failure to maintain sufficient records could be viewed as a violation of the Rule.

 

Can you show me a few examples of what’s allowed and what’s not?

I’d be glad to. Here are a few examples of permissible and prohibited payment structures. 

 

Payment Based on # of Covered Loans Closed

$xxx per unit *

Units 1-30: $275/each

Units 31-60: $300/each

Units 61-90: $350/each

Units 91+: $425/each

 

*1 unit = 1 closed mortgage

Permissible because . . .

A payment is fixed in advance for every loan the originator arranges for the creditor (e.g., $600 for every transaction, or $1,000 for the first 1,000 transactions and $500 for each additional transaction.

 

Monthly Production Bonus

Monthly production bonus

Payment of 50 basis points (bps), or 0.5%, on all funded closed-end mortgages.

 

To qualify for this bonus, more than $200K must be closed and funded during the month.

 

Permissible if . . .

The payment is a fixed percentage based on the entire amount of credit extended during the relevant time period.

 

Prohibited if . . .

The payment is 0% for the first $200K and 0.5% for all loan volume that exceeds $200K.

 


 

 


Annual Production Bonus by Loan Volume

Annual production bonus

$0 - $7,999,999 0% of salary

$8M - $11,999,999 6% of salary

$12M - $14,999,999 9% of salary

$15M+ 12% of salary

 

Based on volume of covered loans closed and funded during the calendar or fiscal year.

 

Let’s assume the LO has a salary of $100K…If loan production hits $8M, there’s a guaranteed bonus of $6K; if production hits $12M, the guaranteed bonus is $9K (not $6K, plus $9K); if production exceeds $15M, the annual bonus is guaranteed at $12K.

Permissible because . . .

A bonus guaranteed in advance to be in a specified amount, in this case a percentage of the base salary, regardless of the terms of transactions of the LO, does not vary with the amount of profits and therefore is not based on them.

 

 

 

That was great, but I have more questions!

We get it! Loan originator compensation requirements are complicated, and we’re glad to help! 



[1] CFPB, Final rule, Loan Originator Compensation Requirements Under the Truth in Lending Act (Regulation Z), 78 Fed. Reg. 11280, 11320 (Feb. 15, 2013) (“LO Release”). 

[2] 1026.36(a)-5.i

[3] 1026.36(a)-5.vi

[4] 1026.36(d)(1)(ii)

[5] 1026.36(d)(1)(iv)(B)(2)

[6] 1026.36(d)(1)-3 ii.

[7] 1026.36(d)(1)-3 ii.

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Brianna Herder, CRCM
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