April 1st may be “All Fools Day” but the federal government isn’t joking about the new mortgage broker compensation rule that takes effect on the same day. This new rule from the Federal Reserve will dramatically change the role mortgage brokers play in the home buying process.
The new rule, known as the Z Loan Originator Compensation and Steering 12 CFR 226, passed by Congress in 2008 under the Truth in Lending Act, will change how mortgage brokers are compensated, ostensibly to safeguard consumers from “unfair practices” involving brokers and loan originators.
According to the Federal Reserve, the new regulation has two core components.
1. The rule prohibits a creditor or any other person from paying, directly or indirectly, compensation to a mortgage broker or any other loan originator that is based on a mortgage transaction’s terms or conditions — the only factor determining pay is the amount of credit extended. The rule also prohibits any person from paying compensation to a loan originator for a particular transaction if the consumer pays the loan originator’s compensation directly.
2. The rule prohibits a loan originator from steering a consumer to consummate a loan that provides the loan originator with greater compensation, as compared to other transactions the loan originator offered or could have offered to the consumer, unless the loan is in the consumer’s interest. The rule provides a safe harbor to facilitate compliance with the prohibition on steering.
What Does This Mean for Consumers?
So what does all that industry-speak mean? Basically, the new rules end the practice of mortgage brokers “steering” new business to mortgage loan providers, most commonly through rebates paid by lenders to brokers in the form of yield-spread premiums. (Yield-spread premiums are payments linked to loan interest rates.)
Now, banks and mortgage lenders can only pay commissions to mortgage brokers that are tied solely and strictly to the mortgage loan amount.
Simply put, this can be bad news for mortgage brokers and a mixed bag for consumers. Prior to this rule, brokers could earn higher commissions for mortgages with higher interest rates and points.
Needless to say, the lending industry is less than thrilled about these changes. “It’s tough to say how it plays out,” says Leif Thomsen, chief executive officer and founder of Mortgage Masters, a Walpole, Mass.-based home loan provider. “We still have 35-40 days before it goes into effect, and we’re hoping it can be changed or postponed. It doesn’t work for mortgage brokers, or for consumers.”
It doesn’t work for consumers? How so? Here are three potential ways in which Regulation Z could impact mortgage borrowers:
1. Higher mortgage costs
With mortgage brokers on the sidelines, lenders and big banks will be dealing more directly with consumers. That, mortgage brokers argue, may ultimately lead to higher costs to borrowers themselves. As bigger banks elbow mortgage brokers out, reduced competition may allow the big lenders to hike interest rates, which would lead to higher mortgage payments to consumers. (Of course, mortgage brokers have a vested interest in that side of the argument — whether it ultimately plays out that well is anybody’ guess.)
More likely, however, is a scenario whether tighter regulations cause mortgage brokers to staff up in order to comply with new accounting rules. “These costs may be passed along to customers,” Thomsen says.
“The reality is that new government regulations and changes how business is conducted almost always results in higher costs to the consumer,” says Keith Gumbinger, vice president at HSH.com, a mortgage research firm based in Pompton Plains, NJ.
2. With less than perfect credit, you may have trouble getting a loan
“From the outset, the new mortgage compensation rules may impinge upon the availability of mortgages for certain borrowers,” says Gumbinger. “The vast majority of mortgages are backed by Freddie Mac and Fannie Mae. Mortgage brokers have always thrived on the fringes of the home loan market, finding loans for people who don’t fit cookie cutter roles for the big government sponsored enterprises like Fannie and Freddie.”
With a lack of tiered compensation, consumers with less than perfect credentials for home loans may have a hard time getting a mortgage. Only the larger, easiest to underwrite loans may receive any attention from mortgage lenders. Banks needn’t bother looking at tougher, smaller loans, as they are awash in business.
Prior to this rule, lenders had a bigger incentive to spend the greater amount of time to make difficult loans happen, since they could charge a commensurately higher fee. Now, brokers will be hamstrung to charge only the lowest available fee combination, so the borrower that would have previously received the attentions of the mortgage broker will now only get a yawn and a hangup.
3. Less help securing the best loan terms available
With fewer mortgage brokers, consumers may miss the “traffic cop” role that brokers have traditionally played in the home loan process – helping home buyers get the lowest interest rates and fees. Of course, consumers can always rely on lending sites that sift through many lenders at once to find the best available mortgage rates and fees based on consumers’ credit profile.
Still, it is too early to be making specific predictions. While it is clear that Fed’s intent is pro-consumer, any time you reduce the competitive playing field, sooner or later consumers may end up paying the freight.
New Mortgage Rules Change the Game For Brokers, Consumers was provided by CreditSesame.com, a free tool that helps people manage their credit, mortgage and debt.