Loan Originator Compensation Rules on the SAFE Exam

Most SAFE exam questions about federal law ask what you must disclose to a borrower. The loan originator compensation rule asks something more personal: how you are allowed to get paid. Federal Mortgage-Related Laws make up 24% of the national SAFE MLO test, and this rule shows up in that domain and in Ethics, because it was written to take the incentive to upsell a borrower out of the paycheck.

The rule lives in Regulation Z section 1026.36, which carries out the loan originator provisions the Dodd-Frank Act added to the Truth in Lending Act. Its main pieces took effect in January 2014. This guide covers who the rule covers, what pay is banned and allowed, the anti-steering safe harbor, and the extra duties that ride along with it.

What the rule covers

The compensation and steering rules apply to closed-end consumer credit secured by a dwelling. That is any dwelling, not just the borrower’s principal residence, so a purchase loan on a second home is covered. Two carve-outs matter for the exam:

• Home equity lines of credit are open-end credit, so they are outside the compensation and steering rules. (The arbitration and credit insurance bans covered later still reach a HELOC secured by the borrower’s principal dwelling.)
• Timeshare loans are excluded from the compensation, steering, qualification, NMLS ID, arbitration, and credit insurance provisions.

Compare that with HOEPA and the HPML rules, which look only at a principal dwelling. The exam likes to swap those scopes.

Who counts as a loan originator

Under Regulation Z, a loan originator is a person who, for compensation or in expectation of it, does any of the following for another person: takes an application, offers, arranges, assists a consumer in obtaining or applying for credit, negotiates, or otherwise obtains or makes an extension of consumer credit. Advertising that you can do those things counts too.

The definition reaches three groups:

• Individual loan originators, such as the MLO who works with the borrower.
• Loan originator organizations, such as a mortgage broker company.
• Creditors that table fund, meaning they close in their own name but do not fund the loan from their own resources, a warehouse line, or deposits. A creditor that funds its own loans is not a loan originator for the pay and steering rules, but every creditor that does origination work is one for the qualification and NMLS ID rules.

The definition does not include:

• Staff who do purely administrative or clerical tasks and never take an application or offer or negotiate terms
• A licensed real estate broker doing only real estate brokerage, unless a creditor or loan originator pays that broker for a particular loan
• Manufactured home retailer employees who do not take applications, offer or negotiate terms, or advise on credit terms
• Certain seller financers that meet the rule’s limits
• Servicers renegotiating or modifying loans for borrowers who are behind, in default, or likely to default

The core ban: no pay based on loan terms

No loan originator may receive, and no person may pay a loan originator, compensation based on a term of a transaction. A term is any right or obligation of the parties to the credit transaction. The commentary lists examples of banned bases for pay:

• The interest rate
• The annual percentage rate
• The collateral type, such as a condominium, cooperative, detached home, or manufactured home
• Whether the loan has a prepayment penalty

The ban also applies across a portfolio. Pay cannot be based on the terms of multiple loans by one originator or by a group of originators, so a bonus tied to the average rate of an LO’s loans is just as illegal as a higher commission on a single high-rate loan.

Proxies count as terms

A creditor cannot get around the rule by paying on something that tracks a term. A factor is a proxy for a term if it consistently varies with that term over a significant number of transactions and the loan originator can add, drop, or change the factor. Regulation Z’s own example: a creditor pays a higher commission on loans it keeps in portfolio, and the only loans it keeps are five-year balloon loans. Portfolio status is standing in for the balloon term, so that commission is banned.

Loan amount is the exception

The amount of credit is not a term for this rule, as long as pay is a fixed percentage of the loan amount. The plan may set a minimum or maximum dollar amount. Paying 1% of the loan amount with a $1,500 floor is fine. Paying 1% on loans above a certain rate and 0.75% on the rest is not.

What pay is allowed

An originator can still be paid differently on different loans, as long as the difference does not come from a term or a proxy. The official commentary lists factors that are acceptable:

Salary is allowed too, since it does not move with any loan’s terms.

Lowering your pay at the closing table

Changing compensation after the fact usually means it was tied to a term. There is one narrow exception: a loan originator may reduce its own compensation to cover an unforeseen increase in an actual settlement cost over the estimate the borrower received, or an unforeseen cost that was never disclosed. An increase is unforeseen only if the original estimate matched the best information reasonably available when it was given.

Retirement plans and profit-based bonuses

Contributions to tax-advantaged retirement plans, such as a 401(k), are allowed, as long as a defined contribution is not based on the terms of that originator’s own loans.

A bonus paid from the company’s mortgage profits is allowed only if it is not based on the terms of that originator’s loans and it meets one of these two limits:

• The profit-based pay is no more than 10% of the originator’s total compensation for the same period, or
• The originator closed 10 or fewer covered transactions in the 12 months before the bonus is determined.

Prizes count. If the bonus is a trip or merchandise, its cash value goes into the 10% calculation.

Dual compensation: one payer per loan

If a loan originator receives compensation directly from the consumer in a transaction, no loan originator may also be paid by anyone else for that transaction, and anyone who knows about the consumer-paid compensation may not pay an originator for it. A broker paid a 1% fee directly by the borrower cannot also take a lender-paid fee on the same loan.

Two details the exam tests:

• When the borrower pays the broker company directly, the company may still pay its own individual LO a commission. That commission still cannot be based on loan terms, although it can be based on the amount the borrower paid the company.
• Money a seller or another third party contributes toward the borrower’s costs, under an agreement with the borrower, counts as paid by the consumer. Payments from the creditor or its affiliates do not.

For the dual compensation rule, affiliates are treated as a single person.

The anti-steering rule

A loan originator may not steer a consumer into a transaction because the originator will earn more on it than on other loans it offered or could have offered, unless the loan is in the consumer’s interest.

Regulation Z gives a safe harbor. For each type of transaction the consumer is interested in, the originator presents loan options that include:

1. The loan with the lowest interest rate
2. The loan with the lowest interest rate without risky features: no negative amortization, prepayment penalty, interest-only payments, balloon payment in the first 7 years, demand feature, shared equity, or shared appreciation
3. The loan with the lowest total dollar amount of discount points, origination points, or origination fees (if there is a tie, the one with the lower rate)

The three types of transaction are a loan whose APR cannot increase after consummation, a loan whose APR can increase, and a reverse mortgage. For a reverse mortgage, the second option is the lowest-rate loan without a prepayment penalty, shared equity, or shared appreciation.

The safe harbor only works if:

• The options come from a significant number of the creditors the originator regularly does business with. The commentary treats three or more creditors as significant, or all of them if the originator works with fewer than three.
• The originator has a good faith belief the consumer likely qualifies for each option shown.
• If more than three loans are shown for a type, the originator highlights the ones that meet the three criteria.

Fewer than three loans is fine if the loans shown still satisfy the criteria. One loan can be the lowest rate, the lowest rate without risky features, and the lowest points all at once.

Exam tip: if a question asks which loan an originator must include for a borrower who wants a fixed rate, look for “lowest rate,” “lowest rate without risky features,” and “lowest points and fees.” The highest-paying loan is never on that list.

Qualification and screening duties

Section 1026.36(f) requires every loan originator to be licensed or registered when the SAFE Act or state law requires it. A loan originator organization must make sure each of its individual LOs is licensed or registered before that person originates.

For employees who are not required to be licensed, such as registered MLOs at a bank or credit union, the organization must do its own screening before the person originates. For anyone hired on or after January 1, 2014, it must obtain:

• A criminal background check, through NMLS for registered MLOs
• A credit report
• Information from NMLS about any administrative, civil, or criminal findings

It must then find that the person has not been convicted of, or pleaded guilty or no contest to, a felony in the past seven years, or a felony involving fraud, dishonesty, breach of trust, or money laundering at any time. Expunged and pardoned convictions do not disqualify the person. The person must also show financial responsibility, character, and general fitness. Finally, the organization must provide periodic training on the federal and state law that applies to the person’s origination work.

Name and NMLS ID on loan documents

The loan originator organization’s name and NMLS ID, and the name and NMLS ID of the individual LO with primary responsibility for the loan, must appear on four documents:

• The credit application
• The Loan Estimate and Closing Disclosure
• The note or loan contract
• The security instrument

The individual’s name must match the name in NMLS.

Two more bans in the same section

• Mandatory arbitration. A loan secured by a dwelling cannot require arbitration or another non-judicial process to settle disputes, and the contract cannot bar a borrower from suing under federal law. After a dispute arises, the parties may still agree to arbitrate.
• Financed credit insurance. A creditor may not finance premiums or fees for credit life, credit disability, credit unemployment, or similar insurance or debt cancellation coverage. Insurance billed and paid in full on a monthly basis is allowed.

Recordkeeping

A creditor must keep records of all compensation it pays loan originators, and a loan originator organization must keep records of all compensation it receives and pays, along with the compensation agreements behind them, for three years after each payment.

Common exam traps

• “Pay can rise with the rate if the borrower agrees.” Borrower consent does not make term-based pay legal.
• Volume vs. terms. More pay for more loans or more dollars closed is fine. More pay for higher rates, a prepayment penalty, or a certain property type is not.
• Percentage of loan amount. Allowed only as a fixed percentage, with an optional minimum and maximum.
• Double dipping. Consumer-paid and creditor-paid compensation can never both go to originators on the same loan.
• HELOCs. Outside the pay and steering rules, but the arbitration and credit insurance bans still apply when the HELOC is secured by the principal dwelling.
• The 7-year balloon. The second safe-harbor option excludes a balloon in the first 7 years, not 5 or 10.
• Felony lookback. Seven years for most felonies, any time for fraud, dishonesty, breach of trust, or money laundering.

Quick review

• Scope: closed-end consumer credit secured by any dwelling; HELOCs and timeshares are out of the pay rules.
• Banned: pay based on a term of the loan, the terms of several loans, or a proxy for a term.
• Allowed: salary, hourly pay, flat per-loan fees, volume, performance, pull-through, file quality, and a fixed percentage of the loan amount.
• Pay may drop only to cover an unforeseen increase in settlement costs.
• Profit-based bonuses: 10% of total pay or 10 or fewer loans in 12 months.
• Dual compensation: if the consumer pays an originator directly, no one else may pay an originator on that loan.
• Anti-steering safe harbor: lowest rate, lowest rate without risky features, lowest points and fees, from three or more creditors, for each loan type.
• Name and NMLS ID go on the application, Loan Estimate, Closing Disclosure, note, and security instrument.
• Compensation records are kept for three years.

Practice this on MLO Pass

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Related study guides

• TILA and Regulation Z: APR, Ads and the Right of Rescission
• RESPA Section 8: Kickbacks, Referral Fees and What’s Allowed
• The SAFE Act: MLO Licensing Rules for the NMLS Exam

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