After the financial meltdown in 2007 and 2008, Congress began carefully scrutinizing many banking practices. Loan officer compensation schemes were identified as one of the contributing factors to the crisis that gripped he nation. Subsequent legislative fixes included provisions in the SAFE Act, Dodd Frank Wall Street Reform and Consumer Protection Act and the Truth in Lending Act (TILA). Provisions on loan officer compensation were codified in Regulation Z.
Regulation Z regulates how loan originators and mortgage brokers can be compensated. The goal of the rule is to protect consumers.
This post examines the rules and identifies opportunities for whistleblowers to earn awards and stop illegal lender behavior. Mortgage industry professionals already familiar with the rules may wish to scroll down to the whistleblower awards subsection.
Loan Officer Compensation Rule Explained
The current Reg Z Loan Officer Compensation rule impacts how loan originators get paid in three ways:
- The rule prohibits a loan officer’s compensation from being based on the terms of the transaction.
- The rule also prohibits loan officers from being compensated by both the borrower and a third party (generally the lender).
- Compensation based on bonus or other formulas tied to the lender’s mortgage related profits may be allowed if not tied to specific transactions.
Although not part of the compensation rules, Regulation Z has many other components. These include certain licensing and training requirements. The rule also imposes specific restrictions and borrower protections in HELOC (home equity) loan transactions.
Definition of Loan Originator (Loan Officer)
We use the term “loan officer” but many folks instead use the term “loan originator”. They are interchangeable for purposes of this post.
According to the rule and CFPB, a loan originator includes “individuals and entities that perform loan origination activities for compensation, such as taking an application, offering credit terms, negotiating credit terms on behalf of a consumer, obtaining an extension of credit for a consumer, or referring a consumer to a loan originator or creditor.” Loan servicers, real estate brokers and salespeople and seller financers are excluded, although it is possible for an individual to where more than one hat in an organization or transaction.
What Loans Are Included?
Almost all residential loan transactions are covered by the rule. (Remember, however, that there are special rules for HELOCs.) The general rule is that if the loan is secured by a dwelling, the transaction is covered by the rule.
The exceptions are commercial transactions, open ended credit arrangements (e.g. HELOC), loans secured by more than 4 residential units and time shares.
What Activities Trigger the Rule?
You are probably a loan originator if you:
- Take a loan application
- Arrange a loan
- “Assist” a borrower in applying for a loan
- Advises a borrower of different products or financing options
- Negotiates loan terms with the borrower
- Extends credit
- Advertises loan services to the public
- Refers a borrower to another loan officer or lender
You are not a loan originator if you are:
- A real estate broker that isn’t compensated by the lender or a loan originator
- An employee that simply prefers clerical tasks for a lender or mortgage broker
- Certain manufactured home retailers
- Most low volume seller financers
What is “Compensation”?
Compensation includes commissions and much more. Bonus payments, salaries, financial incentives, trips, prizes, and merchandise are within the rule’s purview. Also included are stock options and third party payments (commission for selling title insurance).
Some clever mortgage companies have tried to circumvent the rule by calling a bonus an equity dividend. If the loan officer truly has an equity ownership in the company, he and she is entitled to dividends. Those ownership interests must be real and based on one’s capital contribution to the company.
Prohibition Against Compensation Based on Loan Terms
The prohibition against loan officer compensation based on loan terms is the heart of the rule. Congress and regulators want to prevent loan officers from steering borrowers into loans that pay the highest commission. What is good for the lender is often not in the borrower’s best interests.
The most common loan term that lenders previously used to determine commissions was interest rate. Often the higher the rate, the more excesses money that is available to pay commissions. There was a natural incentive to put borrowers in more costly loans simply to get more in commissions. If you are a loan officer, do you want a loan that pays you $500 or $2000?
Because the prohibition against loan term based compensation is the core of the rule, some examples are helpful.
Examples of Legal and Illegal Loan Originator Compensation Schemes
Sally Jones gets a $1000 bonus because she closed more than 5 loans in January with an interest rate of 6% or higher. ILLEGAL!
John Smith gets a $200 bonus because he sold title insurance directly to his borrower. The insurance was sold by an affiliate of the loan officer’s employer instead of a third party. ILLEGAL!
ABC Mortgage pays loan officers a 2% commission on loans with interest rates of 6% or more. Loans with a lower interest rate only carry a 1.5% commission. ILLEGAL!
Sally gets a $50 bonus if the loan she writes has a prepayment penalty clause. ILLEGAL!
The amount of the loan is not considered a term of the loan for purposes of the loan officer compensation rule. Let’s go back to our ABC Mortgage example. If ABC pays a 2% commission and Sally writes a $100,000 loan, she gets $2,000. A $200,000 lon would generate a $4000 commission. As long as the commission percentage remains fixed, the commission arrangement is probably okay.
Other LEGAL arrangements include:
- Hourly wages based on the actual hours worked
- Compensation based on the loan term performance of the officer’s loans
- Pay based on the loan officer’s overall dollar volume
Consult the CFPB or Federal Reserve for More Details
The examples above barely scratch the surface. Lenders have become very creative in how they structure compensation and bonus programs. We can’t cover every scheme in a single blog post. The takeaway is that labels are meaningless. If the compensation is anyway tied to a loan term, it is probably illegal.
For more technical questions, refer to the CFPB Loan Officer Compensation guide booklet.
Whistleblower Rewards for Loan Officer Compensation Violations
We often hear from mortgage industry insiders hoping to clean up dishonest and fraudulent lending practices. It’s hard for an honest loan originator to make a living when so many others are cutting corners and writing bad loans.
The federal False Claims Act allows people with “original source” inside information about fraud to collect an award. The information must relate to loans backed by the FHA, Fannie Mae, Freddie Mac or the VA. The amount of the award is based on the amount of money collected by the government from the wrongdoers. It’s like a commission based on the size of the penalty recovered. (Only the award checks are often in the millions of dollars.)
If you have information about an illegal loan officer compensation scheme or know of other fraud in the underwriting, origination or serving of residential loans, give us a call We have collected over $100,000,000.00 for our mortgage industry whistleblower clients. The next award could be yours.
RPM Mortgage Case
In June of 2015, the CFPB sued RPM Mortgage and its CEO Erwin Hirt for violating the Loan Originator Compensation Rule.
According to the government’s complaint, RPM Mortgage violated the compensation rule. They said RPM paid loan officers in part based on the terms of the loans they wrote. Their plan “gave loan officers a financial incentive to steer customers into higher-rate loans by paying them, in part, based on the interest rates of the loans they closed.” Loans with higher rates created more profits both for RPM and the individual loan officers.
To hide their illegal scheme, the CFPB says “RPM disguised this interest-rate-based compensation by funneling it through so-called employee-expense accounts. RPM deposited profits from an officer’s closed loans – profits that were a direct product of the loans’ interest rates – into the loan officer’s employee-expense account, and then used it to pay her bonuses and increased commissions. RPM also allowed loan officers to use their employee-expense accounts to offset interest-rate reductions or credits for RESPA-tolerance cures or appraisal costs they sometimes granted to avoid losing loans to a competitor.”
This scheme was remarkably similar to a whistleblower case filed against USA Mortgage in St. Louis. In that case, the lender allegedly created expense accounts called “ME accounts.”
History of RPM’s Loan Originator Compensation Scheme
Prior to 2011 and passage of the Loan Officer Compensation Rule, RPM simply allowed loan officers to share in the profits of each loan. Higher interest rate loans, of course, meant more money for RPM and the individual loan officers.
After passage of Regulation Z, RPM simply camouflaged their compensation plan. Under the new scheme, loan officers would get a standard (legal) commission. The company would then deposit an additional sum of money into a designated “employee expense account.” That deposit was – you guessed it – based on the loan terms.
The scheme was so blatant that employees with positive balances didn’t even have to use the money for expenses. Regulators say that loan officers could simply tap their “expense” balance to pay themselves a bonus. It shouldn’t come as a surprise that the bonus amounts “strongly correlated” to the balances in each employee’s expense account.
Court records suggest that although disguised, this scheme was too obvious. CFPB says that RPM soon stopped allowing loan officers to pay themselves bonuses out of their expense account balances. They next allowed the originator to cover the cost of individual commission rate resets. This allowed the originator to effectively get a raise on future loans.
Typically, a significant increase in a loan officer’s commission rate would render a loan unprofitable for RPM. If a loan officer’s commission exceeded the total revenue the loan generated on the secondary market, the transaction would result in an “underage”. This meant that RPM lost money on the deal. The commission resets did not cause RPM to lose money, however. Why? Because any underage was covered by a withdrawal from the employee’s expense account.
CFPB Names CEO Erwin Hirt as a Defendant
Most fraud complaints against banks and lenders only name the company itself. That model is changing. Former Attorney General Loretta Lynch pushed a policy to also name the individual responsible for the alleged scheme. Although the Justice Department did not get involved in this case, many agencies have adopted a similar policy.
The CFPB says that Hirt is both the CEO and a significant owner of RPM. They say that he directly benefitted from the illegal loan officer compensation scheme. More importantly, they say he was the architect of the scheme.
RPM and Hirt Settle
The case against RPM Mortgage was settled the same day it was filed. It was a prenegotiated resolution.
According to the settlement, RPM and Hirt were allowed to settle without any findings of wrongdoing.
Under the terms of the settlement, both RPM and Hirt paid a civil penalty of $1 million. RPM Mortgage agreed to a permanent injunction preventing future violations of the loan officer compensation rules.
Both defendants also agreed to pay the CFPB $18 million to be used to fund restitution for borrowers negatively affected by their actions.
Stand Up Against Fraud (and Perhaps Earn an Award)
Loan officers, underwriters, quality control analysts and servicing reps have a front row seat on illegal mortgage and lending schemes. Millions of Americans lost their jobs, their homes or both because of Wall Street excesses. While we have no problem with companies making healthy profits, they should only be allowed to keep those profits if they play by the rules.
If a scheme impacts on federally backed residential mortgages, chances are good that there is a violation of the False Claims Act. Awards of up to 30% of whatever the government collects from the wrongdoers are available to those who step forward. Because they fight greed and corruption, whistleblowers are the new American heroes.
We aren’t afraid of big mortgage companies and their lawyers. In fact, we proudly represented the whistleblowers that helped the government hit Bank of America for $16.67 billion dollars. (The whistleblower awards in that case were over $150,000,000.) We can’t bring a case, however, without you. If you are interested in learning more, call us and visit our financial fraud whistleblower information page.
For a confidential consultation, contact attorney Brian Mahany at or by phone at (414) 704-6731 (direct). We keep all inquiries in strict confidence.
MahanyLaw – Whistleblower Lawyers for the Mortgage Industry