Truth in Lending, 58509-58538 [2010-22161]

Agencies

• FEDERAL RESERVE SYSTEM

[Federal Register Volume 75, Number 185 (Friday, September 24, 2010)]
[Rules and Regulations]
[Pages 58509-58538]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-22161]



Federal Register / Vol. 75, No. 185 / Friday, September 24, 2010 / 
Rules and Regulations

[[Page 58509]]


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FEDERAL RESERVE SYSTEM

12 CFR Part 226

Regulation Z; Docket No. R-1366


Truth in Lending

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule; official staff commentary.

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SUMMARY: The Board is publishing final rules amending Regulation Z, 
which implements the Truth in Lending Act and Home Ownership and Equity 
Protection Act. The purpose of the final rule is to protect consumers 
in the mortgage market from unfair or abusive lending practices that 
can arise from certain loan originator compensation practices, while 
preserving responsible lending and sustainable homeownership. The final 
rule prohibits payments to loan originators, which includes mortgage 
brokers and loan officers, based on the terms or conditions of the 
transaction other than the amount of credit extended. The final rule 
further prohibits any person other than the consumer from paying 
compensation to a loan originator in a transaction where the consumer 
pays the loan originator directly. The Board is also finalizing the 
rule that prohibits loan originators from steering consumers to 
consummate a loan not in their interest based on the fact that the loan 
originator will receive greater compensation for such loan. The final 
rules apply to closed-end transactions secured by a dwelling where the 
creditor receives a loan application on or after April 1, 2011.

DATES: The final rule is effective on April 1, 2011.

FOR FURTHER INFORMATION CONTACT: Catherine Henderson or Nikita M. 
Pastor, Attorneys; Brent Lattin or Paul Mondor, Senior Attorneys; 
Division of Consumer and Community Affairs, Board of Governors of the 
Federal Reserve System, Washington, DC 20551, at (202) 452-3667 or 
(202) 452-2412; for users of Telecommunications Device for the Deaf 
(TDD) only, contact (202) 263-4869.

SUPPLEMENTARY INFORMATION:

I. Background and Implementation of the Reform Act

A. Background: TILA and Regulation Z

    Congress enacted the Truth in Lending Act (TILA), 15 U.S.C. 1601 et 
seq., based on findings that economic stability would be enhanced and 
competition among consumer credit providers would be strengthened by 
the informed use of credit resulting from consumers' awareness of the 
cost of credit. TILA directs the Board to prescribe regulations to 
carry out its purposes and specifically authorizes the Board, among 
other things, to issue regulations that contain such classifications, 
differentiations, or other provisions, or that provide for such 
adjustments and exceptions for any class of transactions, that in the 
Board's judgment are necessary or proper to effectuate the purposes of 
TILA, facilitate compliance with TILA, or prevent circumvention or 
evasion of TILA. 15 U.S.C. 1604(a).
    In 1995, the Board revised Regulation Z to implement changes to 
TILA made by the Home Ownership and Equity Act (HOEPA). 60 FR 15463; 
Mar. 24, 1995. HOEPA requires special disclosures and substantive 
protections for home-equity loans and refinancings with annual 
percentage rates (APRs) or points and fees above certain statutory 
thresholds. HOEPA also directs the Board to prohibit unfair and 
deceptive acts and practices in connection with mortgages. 15 U.S.C. 
1639(l)(2).
    On August 26, 2009, the Board published a proposed rule in the 
Federal Register pertaining to closed-end credit (August 2009 Closed-
End Proposal). As part of that proposal, the Board proposed to prohibit 
certain compensation payments to loan originators, and to prohibit 
steering consumers to loans not in their interest because the loans 
would result in greater compensation for the loan originator. As stated 
in the Federal Register, this proposal was intended to protect 
consumers against the unfairness, deception, and abuse that can arise 
with certain loan origination compensation practices while preserving 
responsible lending and sustainable homeownership. See 74 FR 43232; 
Aug. 26, 2009. The comment period on the August 2009 Closed-End 
Proposal ended December 24, 2009. The Board received approximately 6000 
comments in response to the proposed rule, including comments from 
creditors, mortgage brokers, trade associations, consumer groups, 
Federal agencies, state regulators, state attorneys general, individual 
consumers, and members of Congress. As discussed in more detail 
elsewhere in this SUPPLEMENTARY INFORMATION, the Board has considered 
comments received on the August 2009 Closed-End Proposal in adopting 
this final rule.

B. The Reform Act

    On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Reform Act) was enacted into law.\1\ Among other 
provisions, Title XIV of the Reform Act amends TILA to establish 
certain mortgage loan origination standards. In particular, Section 
1403 of the Reform Act creates new TILA Section 129B(c), which imposes 
restrictions on loan originator compensation and on steering by loan 
originators. The Board intends to implement Section 129B(c) in a future 
rulemaking after notice and opportunity for further public comment.
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    \1\ Public Law 111-203, 124 Stat. 1376.
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    Many of the provisions in TILA Section 129B(c) are similar to the 
Board's proposed rules concerning loan originator compensation. 
However, Section 129B(c) also has some provisions not addressed by the 
Board's August 2009 Closed-End Proposal. Implementation of those 
provisions of the Reform Act will be addressed in a future rulemaking 
with opportunity for public comment.
    The Board has decided to issue this final rule on loan originator 
compensation and steering, even though a subsequent rulemaking will be 
necessary to implement Section 129B(c). The Board believes that 
Congress was aware of the Board's proposal and that in enacting TILA 
Section 129B(c), Congress sought to codify the Board's proposed 
prohibitions while expanding them in some respects and making other 
adjustments. The Board further believes that it can best effectuate the 
legislative purpose of the Reform Act by finalizing its proposal 
relating to loan origination compensation and steering at this time. 
Allowing enactment of TILA Section 129B(c) to delay final action on the 
Board's prior regulatory proposal would have the opposite effect 
intended by the legislation by allowing the continuation of the 
practices that Congress sought to prohibit.
    In issuing this final rule, the Board is relying on its authority 
in TILA Sections 129(l)(2)(A) and (B) to prohibit acts or practices 
relating to mortgage loans that are unfair and to refinancings of 
mortgage loans that are abusive and not in the interest of the 
borrower. However, this final rule is also consistent with the Reform 
Act for the following reasons: Section 226.36(d)(1) of the final rule 
is consistent with TILA Section 129B(c)(1), which prohibits payments to 
a mortgage loan originator that vary based on the terms of the loan, 
other than the amount of the credit extended. Likewise, the Board finds 
that Sec.  226.36(d)(2) of the final rule is consistent with TILA 
Section 129B(c)(2), which allows mortgage loan originators to receive 
payment from a person other than the consumer (such as

[[Page 58510]]

a yield spread premium paid by the creditor) only if the originator 
does not receive any compensation directly from the consumer. TILA 
Section 129B(c)(2) also imposes a second restriction when an originator 
receives compensation from someone other than the consumer: The 
consumer also must not make any upfront payment to the lender for 
points or fees on the loan other than certain bona fide third-party 
charges. This restriction was not contained in the proposed rule, and 
therefore is not included in this final rule and will be addressed in a 
subsequent rulemaking.
    TILA Section 129B(c)(3) directs the Board to prescribe regulations 
that prohibit loan originators from steering consumers to certain types 
of loans, and prohibits other specified practices. These provisions 
will be also be implemented in a subsequent rulemaking. TILA Section 
129B(c)(3) does not expressly include an anti-steering provision 
similar to proposed Sec.  226.36(e). Nevertheless, the Board continues 
to believe that the prohibition in Sec.  226.36(e) is necessary and 
proper to effectuate and prevent circumvention of the prohibition 
contained in Sec.  226.36(d)(1), and, as explained further below, Sec.  
226.33(e) prohibits acts and practices that are unfair, abusive, and 
not in the interest of the borrower. Thus, the Board is adopting 
proposed Sec.  226.36(e) in the final rule with some modifications in 
response to the public comments.
    The Board's proposed prohibitions related to mortgage originator 
compensation and steering applied to closed-end consumer loans secured 
by real property or a dwelling, but comment was solicited on whether 
the prohibitions also should be applied to home-equity lines of credit 
(HELOCs). However, the provisions of the Reform Act relating to 
originator compensation and steering apply to ``residential mortgage 
loans,'' which include closed-end loans secured by a dwelling or real 
property that includes a dwelling, but exclude HELOCs extended under 
open-end credit plans and timeshare plans (as described in the 
bankruptcy code, 11 U.S.C. 101(53D)). See TILA Section 103(cc)(5), as 
enacted in Section 1401 of the Reform Act.
    The Board is adopting this final rule consistent with the 
definition of ``residential mortgage loan'' in the Reform Act. 
Accordingly, the final rule does not apply to HELOCs or time-share 
transactions. It also does not apply to loans secured by real property 
if such property does not include a dwelling. The Board intends to 
evaluate these issues in connection with future rulemakings and assess 
whether broader coverage is appropriate or necessary.
    The definition of ``loan originator'' used in the proposal and the 
final rule is consistent with the Reform Act's definition of ``mortgage 
originators'' in TILA Section 103(cc)(2). Specifically, TILA Section 
103(cc)(2)(E) excludes certain persons and entities that originate 
loans but are also creditors that provide seller financing for 
properties that the originator owns. Because such persons would be 
``creditors'' and are not loan originators using table funding, they 
are not covered by final rules that are applicable to loan originators.
    The definition of ``loan originator'' in the Board's final rule is 
consistent with the exception in Section 1401 of the Reform Act that 
applies to persons and entities that perform only real estate brokerage 
activities. See TILA Section 103(cc)(2)(D).\2\ This final rule only 
applies to parties who arrange, negotiate, or obtain an extension of 
mortgage credit for a consumer in return for compensation or other 
monetary gain. Thus, persons covered by the final rule would not be 
engaged only in real estate brokerage activities, and would not be 
covered by the statutory exception.
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    \2\ The statutory exception applies to persons or entities that 
are licensed or registered to engage in real estate brokerage 
activities in accordance with applicable State law, and who do not 
receive compensation from a creditor, mortgage broker, or other 
mortgage originator, or their agents.
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    TILA Section 103(cc)(2)(G) contains an exception for loan 
servicers. The final rule only applies to extensions of consumer 
credit. The Board's final rule does not apply to a loan servicer when 
the servicer modifies an existing loan on behalf of the current owner 
of the loan. This final rule does not apply if a modification of an 
existing obligation's terms does not constitute a refinancing under 
Sec.  226.20(a). The Board believes that TILA Section 103(cc)(2)(G) was 
intended to ensure that servicers could continue to modify existing 
loans on behalf of current loan holders. The Board will consider 
whether additional provisions are needed to implement TILA Section 
103(cc)(2)(G) in a future rulemaking.

II. Consumer Protection Concerns With Loan Origination Compensation

A. HOEPA Hearings

    In the summer of 2006, the Board held public hearings on consumer 
protection issues in the mortgage market in four cities. During the 
hearings, consumer advocates urged the Board to ban ``yield spread 
premiums,'' payments that mortgage brokers receive from the creditor at 
closing for delivering a loan with an interest rate that is higher than 
the creditor's ``buy rate.'' Consumer advocates asserted that yield 
spread premiums provide brokers an incentive to increase consumers' 
interest rates unnecessarily. They argued that a prohibition would 
align reality with consumers' perception that brokers serve consumers' 
best interests.
    In light of the information received at the 2006 hearings and the 
rise in defaults that began soon after, the Board held an additional 
hearing in June of 2007 to explore how it could use its authority under 
HOEPA to prevent abusive lending practices in the subprime mortgage 
market while still preserving responsible lending. Although the Board 
did not expressly solicit comment on mortgage broker compensation in 
its notice of the June 2007 hearing, a number of commenters and hearing 
panelists raised the topic. Consumer and creditor representatives alike 
raised concerns about the fairness and transparency of creditors' 
payment of yield spread premiums to brokers. Several commenters and 
panelists stated that consumers are not aware of the payments creditors 
make to brokers, or that such payments increase consumers' interest 
rates. They also stated that consumers may mistakenly believe that a 
broker seeks to obtain the best interest rate available for consumers. 
Consumer groups have expressed particular concern about increased 
payments to brokers for delivering loans both with higher interest 
rates and prepayment penalties.\3\ Several creditors and creditor trade 
associations advocated requiring brokers to disclose whether the broker 
represents the consumer's interests, and how and by whom the broker is 
compensated. Some of these commenters recommended that brokers be 
required to disclose their total compensation to the consumer and that 
creditors be prohibited from paying brokers more than the disclosed 
amount.
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    \3\ See Home Equity Lending Market; Notice of Hearings, 72 FR 
30380; May 31, 2007; Home Equity Lending Market; Notice of Public 
Hearings, 71 FR 26513; May 5, 2006.
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B. The Board's 2008 HOEPA Proposal

    To address concerns raised through the series of HOEPA hearings, 
the Board's 2008 HOEPA Proposed Rule would have prohibited a creditor 
from paying a mortgage broker any compensation greater than the amount 
the consumer had previously agreed in writing that the broker would 
receive. 73 FR 1672, 1698-1700; Jan. 9, 2008. In

[[Page 58511]]

support of the rule, the Board explained its concerns about yield 
spread premiums, which are summarized below.
    A yield spread premium is the present dollar value of the 
difference between the lowest interest rate the wholesale lender would 
have accepted on a particular transaction and the interest rate the 
broker actually obtained for the lender. This dollar amount is usually 
paid to the mortgage broker, though it may also be applied to reduce 
the consumer's upfront closing costs. The creditor's payment to the 
broker based on the interest rate is an alternative to the consumer 
paying the broker directly from the consumer's preexisting resources or 
out of loan proceeds. Thus, consumers potentially benefit from having 
an option to pay brokers for their services indirectly by accepting a 
higher interest rate.
    The Board shares concerns, however, that creditors' payments to 
mortgage brokers are not transparent to consumers and are potentially 
unfair to them. Creditor payments to brokers based on the interest rate 
give brokers an incentive to provide consumers loans with higher 
interest rates. Large numbers of consumers are simply not aware this 
incentive exists. Many consumers do not know that creditors pay brokers 
based on the interest rate, and the current legally required 
disclosures seem to have only a limited effect. Some consumers may not 
even know that creditors pay brokers: a common broker practice of 
charging a small part of its compensation directly to the consumer, to 
be paid out of the consumer's existing resources or loan proceeds, may 
lead consumers incorrectly to believe that this amount is all the 
consumer will pay or the broker will receive. Consumers who do 
understand that the creditor pays the broker based on the interest rate 
may not fully understand the implications of the practice. They may not 
appreciate the full extent of the incentive the practice gives the 
broker to increase the rate because they do not know the dollar amount 
of the creditor's payment.
    Moreover, consumers often wrongly believe that brokers have agreed 
or are required to obtain the best interest rate available. Several 
commenters in connection with the 2006 hearings suggested that mortgage 
broker marketing cultivates an image of the broker as a ``trusted 
advisor'' to the consumer. Consumers who have this perception may rely 
heavily on a broker's advice, and there is some evidence that such 
reliance is common. In a 2003 survey of older borrowers who had 
obtained prime or subprime refinancings, majorities of respondents with 
refinance loans obtained through both brokers and creditors' employees 
reported that they had relied ``a lot'' on their loan originators to 
find the best mortgage for them.\4\ The Board's recent consumer testing 
also suggests that many consumers shop little for mortgages and often 
rely on one broker or lender because of their trust in the 
relationship. In addition, a common perception among consumer testing 
participants was that brokers and lenders have no discretion over their 
loan terms, and, therefore, shopping actively would likely have no 
effect on the terms consumers receive.
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    \4\ See Kellie K. Kim-Sung & Sharon Hermanson, Experiences of 
Older Refinance Mortgage Loan Borrowers: Broker- and Lender-
Originated Loans, Data Digest No. 83, 3 (AARP Public Policy Inst., 
Jan. 2003), available at https://assets.aarp.org/rgcenter/post-import/dd83_loans.pdf.
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    If consumers believe that brokers protect consumers' interests by 
shopping for the lowest rates available, consumers may be less likely 
to take steps to protect their interests when dealing with brokers. For 
example, they may be less likely to shop rates across retail and 
wholesale channels simultaneously to assure themselves that the broker 
is providing a competitive rate. They may also be less likely to shop 
and negotiate brokers' services, obligations, or compensation upfront, 
or at all. They may, for instance, be less likely to seek out brokers 
who will promise in writing to obtain the lowest rate available.
    In response to these concerns, the 2008 HOEPA Proposed Rule would 
have prohibited a creditor from paying a broker more than the consumer 
agreed in writing to pay. Under the proposal, the consumer and mortgage 
broker would have had to enter into a written agreement before the 
broker accepted the consumer's loan application and before the consumer 
paid any fee in connection with the transaction (other than a fee for 
obtaining a credit report). The agreement also would have disclosed (i) 
that the consumer ultimately would bear the cost of the entire 
compensation even if the creditor paid part of it directly; and (ii) 
that a creditor's payment to a broker could influence the broker to 
offer the consumer loan terms or products that would not be in the 
consumer's interest or the most favorable the consumer could obtain.
    Based on the Board's analysis of comments received on the 2008 
HOEPA Proposed Rule, the results of consumer testing, and other 
information, the Board withdrew the proposed provisions relating to 
broker compensation. 73 FR 44522, 44563-65; July 30, 2008. The Board's 
withdrawal of those provisions was based on its concern that the 
proposed agreement and disclosures could confuse consumers and 
undermine their decision making rather than improve it. The risks of 
consumer confusion arose from two sources. First, an institution can 
act as a creditor or broker depending on the transaction. At the time 
the agreement and disclosures would have been required, an institution 
could be uncertain as to which role it ultimately would play. This 
could render the proposed disclosures inaccurate and misleading in some 
and possibly many cases. Second, the Board was concerned by the 
reactions of consumers who participated in one-on-one interviews about 
the proposed agreement and disclosures as part of the Board's consumer 
testing. These consumers often concluded, not necessarily correctly, 
that brokers are more expensive than creditors. Many also believed that 
brokers would serve their best interests notwithstanding the conflict 
resulting from the relationship between interest rates and brokers' 
compensation.\5\ The proposed disclosures presented a significant risk 
of misleading consumers regarding both the relative costs of brokers 
and lenders, and the role of brokers in their transactions.
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    \5\ For more details on the consumer testing, see the report of 
the Board's contractor, Macro International, Inc., Consumer Testing 
of Mortgage Broker Disclosures (July 10, 2008), available at https://www.federalreserve.gov/newsevents/press/bcreg/20080714regzconstest.pdf.
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    In withdrawing the broker compensation provisions of the 2008 HOEPA 
Proposed Rule, the Board stated that it would continue to explore 
options to address potential unfairness associated with loan originator 
compensation arrangements, such as yield spread premiums. The Board 
indicated that it would consider whether disclosures or other 
approaches could effectively remedy this potential unfairness without 
imposing unintended consequences.
    In the August 2009 Closed-End proposal discussed below, the Board 
proposed a more substantive approach to loan originator compensation. 
That proposal is the basis for this final rule.

III. The Board's August 2009 Closed-End Proposal

A. Summary of August 2009 Closed-End Proposal on Loan Originator 
Compensation

    On August 26, 2009, the Board proposed regulations under TILA

[[Page 58512]]

Section 129(l)(2), 15 U.S.C. 1639(l)(2), to prohibit certain 
compensation payments to loan originators and steering to protect 
consumers against the unfairness, deception, and abuse that can arise 
with certain loan origination compensation practices while preserving 
responsible lending and sustainable homeownership. See 74 FR 43232; 
Aug. 26, 2009.
    Specifically, the Board proposed to prohibit a creditor or any 
other person from paying compensation to a loan originator based on the 
terms or conditions of the transaction, or from paying a loan 
originator any compensation if the consumer paid the loan originator 
directly. The Board solicited comment, however, on an alternative that 
would permit compensation based on the loan amount. Under the proposal, 
``loan originator'' would include both mortgage brokers and employees 
of creditors who perform loan origination functions. In addition, the 
Board proposed to apply the prohibition to all mortgage loans secured 
by real property or a dwelling, and solicited comment on whether the 
prohibition should apply to HELOCs.
    The Board also proposed to prohibit a loan originator from steering 
a consumer to a transaction that would yield the most compensation for 
the loan originator, unless the transaction was in the consumer's 
interest. To facilitate compliance with this proposed prohibition, the 
Board proposed a safe harbor. A loan originator would be deemed in 
compliance with the anti-steering prohibition if the consumer chose a 
transaction from a choice of loans with (1) the lowest interest rate, 
(2) the second lowest interest rate, and (3) the lowest settlement 
costs. The Board solicited comment on whether the steering prohibition 
would be effective in achieving its stated purpose, as well as on the 
feasibility and practicality of such a rule, its enforceability, and 
any unintended adverse effects it might have.

B. Overview of Comments Received

    The Board received approximately 6,000 comment letters on the 
proposal from various interested parties, including approximately 1,500 
form letters. Individual mortgage brokers submitted the vast majority 
of comments. The remaining commenters included mortgage lenders, banks, 
community banks, credit unions, secondary market participants, industry 
trade groups, consumer advocates, Federal banking agencies, members of 
Congress, state regulators, state attorneys general, academics, and 
individual consumers.
    Many commenters supported the Board's proposal to protect consumers 
from certain loan origination compensation practices. Consumer 
advocates supported the expanded definition of ``loan originators'' to 
include loan officers, because employees of creditors face the same 
incentives as mortgage brokers. They also supported covering all 
closed-end transactions regardless of loan price. Many of these 
commenters supported the Board's proposed anti-steering rule, but 
expressed some reservations on the breadth of the proposed safe harbor.
    In contrast, industry commenters generally opposed the proposed 
prohibition on loan originator compensation based on the terms or 
conditions of the transaction, as well as the proposed anti-steering 
rule. Many of these commenters expressed concerns regarding the breadth 
of the definition of ``loan originator,'' and urged the Board to limit 
the scope of its definition to individuals. Further, these commenters 
urged the Board to limit the scope of the proposal to higher-priced 
loans because the abuses targeted by the prohibition have historically 
been limited to the subprime market. In addition, many community banks, 
credit unions, and mortgage brokers maintained that prohibiting these 
types of origination compensation practices would hurt small businesses 
and reduce competition in the mortgage market. They argued that the 
proposal would increase the cost of credit for consumers.
    These comments are discussed in further detail below in part VI.

IV. Summary of Final Rule

    The Board is issuing final rules amending Regulation Z to prohibit 
certain practices relating to payments made to compensate mortgage 
brokers and other loan originators. The goal of the amendments is to 
protect consumers in the mortgage market from unfair practices 
involving compensation paid to loan originators. The final 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, except 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.
    The final rule adopts the proposal that 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. A 
loan originator is deemed to comply with the anti-steering prohibition 
if the consumer is presented with loan options that provide (1) the 
lowest interest rate; (2) no risky features, such as a prepayment 
penalty, negative amortization, or a balloon payment in the first seven 
years; and (3) the lowest total dollar amount for origination points or 
fees and discount points.
    The final rule applies to loan originators, which are defined to 
include mortgage brokers, including mortgage broker companies that 
close loans in their own names in table-funded transactions, and 
employees of creditors that originate loans (e.g., loan officers). 
Thus, creditors are excluded from the definition of a loan originator 
when they do not use table funding, whether they are a depository 
institution or a non-depository mortgage company, but employees of such 
entities are loan originators. The final rule covers all transactions 
secured by a dwelling, but excludes HELOCs extended under open-end 
credit plans and timeshare transactions. The rule requires creditors 
and other persons who compensate loan originators to retain records for 
at least two years after a mortgage transaction is consummated.
    As discussed further in part VII, the Board has determined that 
compliance with this final rule shall become mandatory on April 1, 
2011. Accordingly, the final rule applies to transactions for which the 
creditor receives an application on or after April 1, 2011. The Board 
believes that this date gives parties sufficient time to develop new 
business models, train employees, and makes system changes to implement 
the rule's requirements. The Board has considered whether it would be 
appropriate to delay the effective date of this final rule so that the 
rules related to mortgage loan origination standards in the Reform Act 
could be implemented at the same time. Although such a delay might 
facilitate compliance and result in some cost savings, the Board finds 
that the benefits to consumers of an earlier effective date for rules 
pertaining to loan origination compensation and steering greatly 
outweigh any potential savings.

V. Legal Authority

A. General Rulemaking Authority

    TILA Section 105 mandates that the Board prescribe regulations to 
carry out

[[Page 58513]]

the purposes of the Act. TILA also specifically authorizes the Board, 
among other things, to:
     Issue regulations that contain such classifications, 
differentiations, or other provisions, or that provide for such 
adjustments and exceptions for any class of transactions, that in the 
Board's judgment are necessary or proper to effectuate the purposes of 
TILA, facilitate compliance with the Act, or prevent circumvention or 
evasion. 15 U.S.C. 1604(a).
     Exempt from all or part of TILA any class of transactions 
if the Board determines that TILA coverage does not provide a 
meaningful benefit to consumers in the form of useful information or 
protection. The Board must consider factors identified in the Act and 
publish its rationale at the time it proposes an exemption for comment. 
15 U.S.C. 1604(f).
    In the course of developing this final rule, the Board has 
considered the views of interested parties, its experience in 
implementing and enforcing Regulation Z, and the results obtained from 
testing various disclosure options in controlled consumer tests. For 
the reasons discussed in this notice, the Board believes this final 
rule is appropriate pursuant to the authority under TILA Section 
105(a).

B. The Board's Authority Under TILA Section 129(l)(2)

    TILA Section 129(l)(2) authorizes the Board to prohibit acts or 
practices in connection with:
     Mortgage loans that the Board finds to be unfair, 
deceptive, or designed to evade the provisions of HOEPA; and
     Refinancing of mortgage loans that the Board finds to be 
associated with abusive lending practices or that are otherwise not in 
the interest of the borrower.

15 U.S.C. 1639(l)(2). The authority granted to the Board under TILA 
Section 129(l)(2) is broad. It reaches mortgage loans with rates and 
fees that do not meet HOEPA's rate or fee trigger in TILA Section 
103(aa), 15 U.S.C. 1602(aa), as well as mortgage loans not covered 
under that Section, such as home purchase loans. Moreover, while 
HOEPA's statutory restrictions apply only to creditors and only to loan 
terms or lending practices, TILA Section 129(l)(2) is not limited to 
acts or practices by creditors, nor is it limited to loan terms or 
lending practices. See 15 U.S.C. 1639(l)(2). It authorizes protections 
against unfair or deceptive practices ``in connection with mortgage 
loans,'' and it authorizes protections against abusive practices ``in 
connection with refinancing of mortgage loans.'' Thus, the Board's 
authority is not limited to regulating specific contractual terms of 
mortgage loan agreements; it extends to regulating loan-related 
practices generally, within the standards set forth in the statute.
    HOEPA does not set forth a standard for what is unfair or 
deceptive, but the Congressional Conference Report for HOEPA indicates 
that, in determining whether a practice in connection with mortgage 
loans is unfair or deceptive, the Board should look to the standards 
employed for interpreting state unfair and deceptive trade practices 
statutes and the Federal Trade Commission Act (FTC Act), Section 5(a), 
15 U.S.C. 45(a).\6\
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    \6\ H.R. Rep. 103-652, 162 (Aug. 1994) (Conf. Rep.).
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    Congress has codified standards developed by the Federal Trade 
Commission (FTC) for determining whether acts or practices are unfair 
under Section 5(a), 15 U.S.C. 45(a).\7\ Under the FTC Act, an act or 
practice is unfair when it causes or is likely to cause substantial 
injury to consumers, which is not reasonably avoidable by consumers 
themselves and not outweighed by countervailing benefits to consumers 
or to competition. In addition, in determining whether an act or 
practice is unfair, the FTC is permitted to consider established public 
policies, but public policy considerations may not serve as the primary 
basis for an unfairness determination.\8\
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    \7\ See 15 U.S.C. 45(n); Letter from Commissioners of the FTC to 
the Hon. Wendell H. Ford, Chairman, and the Hon. John C. Danforth, 
Ranking Minority Member, Consumer Subcomm. of the H. Comm. on 
Commerce, Science, and Transp. (Dec. 17, 1980).
    \8\ 15 U.S.C. 45(n).
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    The FTC has interpreted these standards to mean that consumer 
injury is the central focus of any inquiry regarding unfairness.\9\ 
Consumer injury may be substantial if it imposes a small harm on a 
large number of consumers, or if it raises a significant risk of 
concrete harm.\10\ The FTC looks to whether an act or practice is 
injurious in its net effects.\11\ The FTC has also observed that an 
unfair act or practice will almost always reflect a market failure or 
market imperfection that prevents the forces of supply and demand from 
maximizing benefits and minimizing costs.\12\ In evaluating unfairness, 
the FTC looks to whether consumers' free market decisions are 
unjustifiably hindered.\13\
---------------------------------------------------------------------------

    \9\ Statement of Basis and Purpose and Regulatory Analysis, 
Credit Practices Rule, 42 FR 7740, 7743; Mar. 1, 1984 (Credit 
Practices Rule).
    \10\ Letter from Commissioners of the FTC to the Hon. Wendell H. 
Ford, Chairman, and the Hon. John C. Danforth, Ranking Minority 
Member, Consumer Subcomm. of the H. Comm. on Commerce, Science, and 
Transp., n.12 (Dec. 17, 1980).
    \11\ Credit Practices Rule, 42 FR at 7744.
    \12\ Id.
    \13\ Id.
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    The FTC has also adopted standards for determining whether an act 
or practice is deceptive (though these standards, unlike unfairness 
standards, have not been incorporated into the FTC Act).\14\ First, 
there must be a representation, omission, or practice that is likely to 
mislead the consumer. Second, the act or practice is examined from the 
perspective of a consumer acting reasonably in the circumstances. 
Third, the representation, omission, or practice must be material, that 
is, it must be likely to affect the consumer's conduct or decision with 
regard to a product or service.\15\
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    \14\ Letter from James C. Miller III, Chairman, FTC to the Hon. 
John D. Dingell, Chairman, H. Comm. on Energy and Commerce (Oct. 14, 
1983) (Dingell Letter).
    \15\ Dingell Letter at 1-2.
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    Many states also have adopted statutes prohibiting unfair or 
deceptive acts or practices, and these statutes employ a variety of 
standards, many of them different from the standards currently applied 
under the FTC Act. A number of states follow an unfairness standard 
formerly used by the FTC. Under this standard, an act or practice is 
unfair where it offends public policy or is immoral, unethical, 
oppressive, or unscrupulous, and causes substantial injury to 
consumers.\16\
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    \16\ See, e.g., Kenai Chrysler Ctr., Inc. v. Denison, 167 P.3d 
1240, 1255 (Alaska 2007) (quoting FTC v. Sperry & Hutchinson Co., 
405 U.S. 233, 244-45 n.5 (1972)); State v. Moran, 151 N.H. 450, 452, 
861 A.2d 763, 755-56 (N.H. 2004) (concurrently applying the FTC's 
former test and a test under which an act or practice is unfair or 
deceptive if ``the objectionable conduct * * * attain[s] a level of 
rascality that would raise an eyebrow of someone inured to the rough 
and tumble of the world of commerce'') (citation omitted); Robinson 
v. Toyota Motor Credit Corp., 201 Ill. 2d 403, 417-418, 775 N.E.2d 
951, 961-62 (2002) (quoting FTC v. Sperry & Hutchinson Co., 405 U.S. 
233, 244-45 n.5 (1972)).
---------------------------------------------------------------------------

    In adopting this final rule under TILA Section 129(l)(2)(A), 15 
U.S.C. 1639(l)(2)(A), the Board has considered the standards currently 
applied to the FTC Act's prohibition against unfair or deceptive acts 
or practices, as well as the standards applied in similar state 
statutes.

VI. Section-by-Section Analysis of Final Rules for Loan Origination 
Compensation

A. Overview

    This part VI discusses the prohibitions on certain compensation 
payments to loan originators and steering. To address the unfairness 
that arises with certain loan originator compensation practices, the 
final rule prohibits creditors or any other person

[[Page 58514]]

from paying compensation to a loan originator based on the terms or 
conditions of the credit transaction, other than the amount of credit 
extended. This prohibition does not apply to payments that consumers 
make directly to a loan originator. However, if the loan originator 
receives payments directly from the consumer, the loan originator is 
prohibited from also receiving compensation from any other party in 
connection with that transaction. In addition, the final rule prohibits 
a loan originator from steering consumers to loans not in their 
interest because the loans would result in greater compensation for the 
loan originator. Similar to the proposed rule, the final rule provides 
a safe harbor to facilitate compliance with the steering prohibition, 
with some modifications.
    As discussed in further detail below, the Board finds that these 
prohibitions on payments to loan originators and steering are necessary 
and appropriate to prevent practices that the Board deems unfair in 
connection with mortgage loans and that are associated with abusive 
lending practices or are otherwise not in the interest of the consumer 
in connection with refinancings. See TILA Section 129(l)(2), 15 U.S.C. 
1639(l)(2), and the discussion of this statutory authority in part IV 
above.

B. Public Comment

    Industry commenters and their trade groups generally, although not 
uniformly, opposed the proposal to prohibit loan originator 
compensation based on the terms or conditions of the transaction. These 
commenters stated that such a prohibition would hurt small businesses, 
especially mortgage brokers, as well as community banks and credit 
unions. They maintained that adopting the proposed prohibition would 
increase the cost of credit for all creditors and consumers. Some 
industry commenters also suggested alternatives such as imposing a cap 
on originator compensation and requiring improved disclosures. They 
noted that the U.S. Department of Housing and Urban Development's (HUD) 
recently revised the disclosures required under the Real Estate 
Settlement Procedures Act (RESPA), including disclosures about yield 
spread premiums. They stated that the RESPA rules had only recently 
take effect,\17\ and urged the Board to wait until a determination 
could be made as to whether the disclosures could resolve concerns 
about originator compensation.
---------------------------------------------------------------------------

    \17\ See 73 FR 68204; Nov. 17, 2008.
---------------------------------------------------------------------------

    However, industry commenters generally suggested that if the Board 
chooses to finalize the proposed prohibitions, the Board should permit 
payments to loan originators based on the principal loan amount. They 
asserted that prohibiting payments based on the loan amount would 
disrupt the secondary market. Industry commenters uniformly opposed 
expanding the proposed prohibitions to HELOCs, citing a lack of abuse 
in the HELOC market as the principal reason.
    In contrast, consumer groups, state and Federal regulators, state 
attorneys general, and several members of Congress strongly supported 
the proposed prohibition on loan originator compensation based on the 
terms or conditions of the transaction. They stated that by removing 
reliance on loan terms or conditions to set compensation for loan 
originators, the rule seeks to correct the misaligned incentives that 
currently exist in the mortgage marketplace between loan originators 
and consumers. However, some of these commenters did not support 
allowing compensation based on the principal loan amount. They argued 
that permitting payments to loan originators based on the loan amount 
may encourage loan originators to ``upsell'' the loan amount and 
discourage others from originating small balance loans. Some 
commenters, especially consumer advocates, sought additional 
protections, such as disclosures and prohibitions on creditors paying 
any compensation to a loan originator unless the creditor's payment 
covered all fees and charges associated with the loan, not just the 
compensation paid to the loan originator.
    Many of these commenters supported expanding the definition of 
``loan originator'' to include both mortgage brokers and employees of 
creditors. They stated that overages paid to retail originators are 
equally harmful to consumers as compensation paid to mortgage brokers; 
both provide incentives for the loan originator to steer the consumer 
to a loan that will yield the originator the greatest amount of 
compensation. In addition, they urged the Board to extend the scope of 
the proposed prohibition to the entire mortgage market, including 
HELOCs, to prevent unfair compensation practices from migrating from 
one market segment to another.
    In response to the proposed prohibition on steering, consumer 
advocates, other Federal banking agencies, members of Congress, state 
regulators, and state attorneys general expressed support overall. 
Certain consumer advocates and state officials argued, however, that 
the proposed safe harbor for steering substantially weakened the 
proposed prohibitions on compensation practices. These commenters urged 
the Board to replace the safe harbor with a rebuttable presumption if 
the transaction's terms or conditions met certain criteria, such as a 
competitive interest rate and no prepayment penalty.
    In contrast, the vast majority of industry commenters opposed the 
steering prohibition. They argued that the steering prohibition and 
proposed safe harbor were too vague and would increase litigation risk. 
They suggested that, at a minimum, the Board provide a broader safe 
harbor for the steering prohibition to facilitate compliance and lessen 
litigation risk.
    These comments are discussed in further detail throughout this part 
as applicable.

C. Unfair and Deceptive Acts and Practices Analysis

    The Board proposed to use its HOEPA authority to prohibit unfair 
compensation practices in connection with transactions secured by real 
property or a dwelling. TILA Section 129(l)(2)(A), 15 U.S.C. 
1639(l)(2)(A). TILA Section 129(l)(2) authorizes the Board to prohibit 
acts or practices in connection with mortgage loans that the Board 
finds to be unfair or deceptive. As discussed above in part V, in 
considering whether a practice is unfair or deceptive under TILA 
Section 129(l)(2), the Board has generally relied on the standards that 
have been adopted for purposes of Section 5(a) of the FTC Act, 15 
U.S.C. 45(a), which also prohibits unfair and deceptive acts and 
practices. For purposes of the FTC Act, an act or practice is 
considered unfair when it causes or is likely to cause substantial 
injury to consumers that is not reasonably avoidable by consumers 
themselves and not outweighed by countervailing benefits to consumers 
or to competition.
    As explained in further detail below, the Board finds that paying 
loan originators based on the terms or conditions of the loan, other 
than the amount of credit extended, or steering consumers to loans that 
are not in their interest to maximize loan originator compensation, are 
unfair practices. Furthermore, based on its experience with consumer 
testing, particularly in connection with the 2008 HOEPA Proposed Rule, 
the Board believes that disclosure alone is insufficient for most 
consumers to avoid the harm caused by this practice. Thus, the Board is 
adopting substantive regulations to prohibit these unfair practices

[[Page 58515]]

substantially as proposed. This section discusses (1) the substantial 
injuries caused to consumers by these unfair compensation practices; 
(2) the reasons consumers cannot reasonably avoid these injuries; and 
(3) the basis for the Board concluding that the injuries are not 
outweighed by the countervailing benefits to consumers or competition 
when creditors engage in these unfair compensation practices.
Substantial Injury
    When loan originators receive compensation based on a transaction's 
terms and conditions, they have an incentive to provide consumers loans 
with higher interest rates or other less favorable terms. Yield spread 
premiums, therefore, present a significant risk of economic injury to 
consumers. Currently, this injury is common because consumers typically 
are not aware of the practice or do not understand its implications, 
and thus cannot effectively limit the practice.
    Creditors' payments to mortgage brokers or their own employees that 
originate loans (loan officers) generally are not transparent to 
consumers. Brokers may impose a direct fee on the consumer, which may 
lead consumers to believe that the direct fee is the sole source of the 
broker's compensation. While consumers expect the creditor to 
compensate its own loan officers, they do not necessarily understand 
that the loan originator may have the ability to increase the 
creditor's interest rate or include certain loan terms for the 
originator's own gain.
    Because consumers generally do not understand the yield spread 
premium mechanism, they are unable to engage in effective negotiation. 
Instead they are more likely to rely on the loan originator's advice, 
and, as a result, may receive a higher rate or other unfavorable terms 
solely because of greater originator compensation. These consumers 
suffer substantial injury by incurring greater costs for mortgage 
credit than they would otherwise be required to pay.
Injury Not Reasonably Avoidable
    Yield spread premiums create a conflict of interest between the 
loan originator and consumer. As noted above, many consumers are not 
aware of creditor payments to loan originators, especially in the case 
of mortgage brokers, because these arrangements lack transparency. 
Although consumers may reasonably expect creditors to compensate their 
own employees, consumers do not know how the loan officer's 
compensation is structured or that loan officers can increase the 
creditor's interest rate or offer certain loan terms to increase their 
own compensation. Without this understanding, consumers cannot 
reasonably be expected to appreciate or avoid the risk of financial 
harm these arrangements represent.
    To guard against this practice, a consumer would have to know the 
lowest interest rate the creditor would have accepted, and ascertain 
that the offered interest rate includes a rate increase by the loan 
originator. Most consumers will not know the lowest rate the creditor 
would be willing to accept. The consumer also would need to understand 
the dollar amount of the yield spread premium that is generated by the 
rate increase to determine what portion, if any, is being applied to 
reduce the consumer's upfront loan charges. HUD recently adopted 
disclosures in Regulation X (24 CFR Part 3500), which implement RESPA 
and that could enhance some consumers' understanding of mortgage broker 
compensation. But the details of the compensation arrangements are 
complex and the disclosures are limited. Pursuant to Regulation X, a 
mortgage broker or lender shows the yield spread premium as a credit to 
the borrower that is applied to cover upfront costs, but also adds the 
amount of the yield spread premium to the total origination charges 
being disclosed. This disclosure would not necessarily inform the 
consumer that the rate has been increased by the originator and that a 
lower rate with a smaller origination charge may be available. In 
addition, the Regulation X disclosure concerning yield spread premiums 
would not apply to compensation paid to a loan originator that is 
employed by the creditor. Thus, the Regulation X disclosure, while 
perhaps an improvement over previous rules, is not likely by itself to 
prevent consumers from incurring substantial injury from the practice.
    Yield spread premiums are complex and may be counter-intuitive even 
to well-informed consumers. Based on the Board's experience with 
consumer testing, the Board believes that disclosures are insufficient 
to overcome the gap in consumer comprehension regarding this critical 
aspect of the transaction. Currently, the required disclosures of 
originator compensation under Federal and state laws seem to have 
little, if any, effect on originators' incentive to provide consumers 
with increased interest rates or other unfavorable loan terms to 
increase the originators' compensation.\18\ The Board's consumer 
testing indicated that disclosures about yield spread premiums are 
ineffective. Consumers in these tests did not understand yield spread 
premiums and how they create an incentive for loan originators to 
increase consumers' costs.
---------------------------------------------------------------------------

    \18\ For example, some creditors may be willing to offer a loan 
with a lower interest rate in return for including a prepayment 
penalty. A loan originator that offers a loan with a prepayment 
penalty may not offer the lower rate, however, resulting in a 
premium interest rate and the payment of a yield spread premium.
---------------------------------------------------------------------------

    Consumers' lack of comprehension of yield spread premiums is 
compounded where the originator imposes a direct charge on the 
consumer. A mortgage broker may charge the consumer a direct fee for 
arranging the consumer's mortgage loan. This charge may lead the 
consumer to infer that the broker accepts the consumer-paid fee to 
represent the consumer's financial interests. Consumers also may 
reasonably believe that the fee they pay is the originator's sole 
compensation. This may lead reasonable consumers erroneously to believe 
that loan originators are working on their behalf, and are under a 
legal or ethical obligation to help them obtain the most favorable loan 
terms and conditions. Consumers may regard loan originators as 
``trusted advisors'' or ``hired experts,'' and consequently rely on 
originators' advice. Consumers who regard loan originators in this 
manner are far less likely to shop or negotiate to assure themselves 
that they are being offered competitive mortgage terms. Even for 
consumers who shop, the lack of transparency in originator compensation 
arrangements makes it unlikely that consumers will avoid yield spread 
premiums that unnecessarily increase the cost of their loan.
    Consumers generally lack expertise in complex mortgage transactions 
because they engage in such mortgage transactions infrequently. Their 
reliance on loan originators is reasonable in light of originators' 
greater experience and professional training in the area, the belief 
that originators are working on their behalf, and the apparent 
ineffectiveness of disclosures to dispel that belief.
Injury Not Outweighed by Benefits to Consumers or to Competition
    Yield spread premiums may benefit consumers in cases where the 
amount is applied to reduce consumers' upfront closing costs, including 
originator compensation. A creditor's increase in the interest rate (or 
the addition of other loan terms) may be used to generate additional 
income that the creditor uses to compensate the originator, in lieu of 
adding origination points or fees that

[[Page 58516]]

the consumer would be required to pay directly from the consumer's 
preexisting funds or the loan proceeds. This can benefit a consumer who 
lacks the resources to pay closing costs in cash, or who may have 
insufficient equity in the property to increase the loan amount to 
cover these costs.
    Without a clear understanding of yield spread premiums, the 
majority of consumers are not equipped to police the market to ensure 
that yield spread premiums are in fact applied to reduce their closing 
costs, especially in the case of loan originator compensation. Such 
policing would be particularly difficult because consumers are not 
likely to have any basis for determining a ``typical'' or 
``reasonable'' amount for originator compensation. Accordingly, the 
Board is amending Regulation Z to prohibit any person from basing a 
loan originator's compensation on the loan's terms or conditions, other 
than the amount of credit extended. However, the final rule still 
afford creditors the flexibility to structure loan pricing to preserve 
the potential consumer benefit of compensating an originator, or 
funding third-party closing costs, through the interest rate.

D. Final Rules Prohibiting Certain Payments to Loan Originators and 
Steering

    The Board proposed in Sec.  226.36(d)(1) to prohibit any person 
from compensating a loan originator, directly or indirectly, based on 
the terms or conditions of a loan transaction secured by real property 
or a dwelling. The prohibition extends to all persons, not just the 
creditor, to prevent evasion by structuring payments to loan 
originators through non-creditors, such as secondary market investors. 
Under the proposal, compensation based on the loan amount would be 
prohibited as a payment that is based on a term or condition of the 
loan, but comment was sought on an alternative proposal that would 
permit such compensation.
    The proposed prohibition did not apply to consumers' direct 
payments to loan originators. However, where the consumer compensated 
the loan originator directly, proposed Sec.  226.36(d)(2) prohibited 
the loan originator from also receiving compensation from the creditor 
or any other person. The proposal applied to all ``loan originators,'' 
which included employees of the creditor in addition to mortgage 
brokers, and to all closed-end transactions secured by real property or 
a dwelling.
    The Board also proposed in Sec.  226.36(e)(1) to prohibit a loan 
originator from steering a consumer to consummate a loan that may not 
be in the consumer's interest to maximize the loan originator's 
compensation. Proposed Sec. Sec.  226.36(e)(2) and (3) provided a safe 
harbor: No violation of the steering prohibition would occur if, under 
certain conditions, the consumer was presented with at least three loan 
options for each type of transaction (fixed-rate or adjustable-rate 
loan) in which the consumer expressed an interest. Proposed commentary 
provided additional guidance regarding the prohibition on steering and 
the safe harbor.
    The Board is adopting the prohibition on originator compensation 
that is based on the terms or conditions of the loan, substantially as 
proposed. The Board is also adopting the alternative proposal that 
permits compensation that is based on the amount of credit extended. 
The Board is revising the proposed commentary to provide further 
clarification regarding compensation payments that do and do not 
violate the prohibition, including clarifications concerning the use of 
credit scores and similar indicators of credit risk. The Board is also 
adopting the final rule prohibiting steering as proposed, with 
modifications to the safe harbor and corresponding commentary. These 
provisions are discussed in further detail below.

Section 226.36 Prohibited Acts or Practices in Connection With Credit 
Secured by a Dwelling

Definition of ``Loan Originator''
    As discussed below in more detail, the Board proposed to prohibit 
certain payments to loan originators based on transaction terms or 
conditions, and also proposed to prohibit a loan originator from 
``steering'' consumers to transactions that are not in their interest, 
to increase the loan originator's compensation. Accordingly, the Board 
proposed in Sec.  226.36(a)(1) to define the term ``loan originator'' 
to include persons who are covered by the current definition of 
``mortgage broker'' in Sec.  226.36(a) and employees of the creditor 
who are not otherwise already considered ``mortgage brokers.'' (Section 
226.36(a) currently defines the term ``mortgage broker'' because a 
mortgage broker is subject to the prohibition on coercion of appraisers 
in existing Sec.  226.36(b).) The Board further proposed to clarify 
under the proposed definition of ``loan originator'' that a creditor in 
a ``table-funded transaction'' that is not funding the transaction at 
consummation out of its own resources, including drawing on a bona fide 
warehouse line of credit or out of its deposits, is considered a 
``mortgage broker.'' No substantive change was intended other than to 
adopt the definition of ``loan originator.'' The Board proposed to 
revise and redesignate the existing definition of ``mortgage broker'' 
under Sec.  226.36(a) as new Sec.  226.36(a)(2).
    Public Comment. Industry commenters and their trade groups strongly 
opposed the proposed definition of ``loan originator'' in Sec.  
226.36(a) because they opposed the scope of coverage for the proposed 
prohibitions on compensation in Sec.  226.36(d). They argued that the 
rule should not apply to compensation paid by creditors to their 
employees because creditors have greater capital requirements, face 
significant oversight and regulation, and are motivated by concern for 
their reputation, and, therefore, do not engage in unfair compensation 
practices. Independent mortgage companies and their trade groups 
further argued that, unlike mortgage brokers, they do not present 
themselves to consumers as being able to shop loans offered by 
different creditors, but originate loans exclusively for themselves 
using their own resources. These commenters argued that this 
distinction prevents employees of independent mortgage banking 
companies from engaging in the abuses targeted by the rule, and, 
therefore, it is unnecessary to extend the rule's prohibitions on 
compensation to them.
    Community banks and their trade groups contended that they should 
be excluded from the definition of loan originator because such banks 
and employees have a vested interest in their communities and 
consumers, and therefore take more time to educate and inform 
consumers. They noted that they hold most of their loans in portfolio 
rather than selling them to the secondary market, and have not engaged 
in the abusive practices targeted by the rule. Similarly, a credit 
union trade association argued that its members should be excluded from 
the definition of ``loan originator.'' This commenter stated that loan 
originator compensation encourages credit union employees to ensure 
that consumers obtain the loan best suited for them in order to 
maximize customer satisfaction, because credit union employees share in 
the profit generated by high loan volumes. Other industry commenters 
urged the Board to exempt managers, supervisors, and technical or 
administrative employees from the definition of ``loan originator.'' 
These commenters said that such employees have little, if any, impact 
on terms or conditions of individual loans and their

[[Page 58517]]

compensation does not rely on originated loans.
    Some industry commenters urged the Board to exclude companies and 
other entities from the proposed definition of ``loan originator'' and 
instead adopt the definition of ``loan originator'' provided for by 
Congress in the Safe Mortgage Licensing Act (SAFE Act), which covers 
only natural persons and not entities. Mortgage brokers, together with 
some other commenters including the Small Business Administration (the 
SBA), argued that the proposed definition of ``loan originator'' in 
Regulation Z would be broader than the SAFE Act definition, without 
justification. Specifically, the mortgage brokers and the SBA argued 
the proposal would disproportionately affect small brokerage firms and 
create an unlevel playing field. They stated that large brokerage firms 
would be ``creditors'' who are not subject to the compensation 
restrictions, because they can and would fund loans out of their own 
resources, such as by drawing on bona fide warehouse lines of credit. 
They claimed that the proposal would force small brokerage firms who 
are unable to fund loans out of their own resources out of the 
marketplace.
    Consumer advocates and state attorneys general supported the 
proposed definition of loan originator. They noted that, like third-
party originators, employees of creditors receive compensation based on 
loan terms and conditions, a practice that provides incentives to 
direct consumers to costlier loans.
    Discussion. The Board is adopting the definition of loan originator 
in Sec.  226.36(a)(1) as proposed, with some clarifications. As 
discussed above, the final rule is aimed at abuses associated with 
creditors' compensation payments to loan originators for originating 
loans with interest rates above the creditor's minimum or ``par'' 
interest rate or other less favorable terms, such as a prepayment 
penalty. The final rule applies whether the creditor's payment is made 
to a natural person, including an employee of the creditor, or a 
business entity. The rule does not apply to payments received by a 
creditor when selling the loan to a secondary market investor. When a 
mortgage brokerage firm originates a loan, it is not exempt under the 
final rule unles