[Federal Register Volume 75, Number 185 (Friday, September 24, 2010)]
[Rules and Regulations]
[Pages 58509-58538]
From the Federal Register Online via the Government Publishing 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 http://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 http://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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \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 unless it is also a creditor that funds the loan from its 
own resources, such as its own line of credit.
    Similar to mortgage brokers, creditors' employees have significant 
discretion over loan pricing, and therefore are able to modify the 
loan's terms or conditions to increase their own compensation. Ample 
anecdotal evidence indicates that creditors' loan officers engage in 
such pricing discretion that directly harms consumers.\19\ The Board 
believes that where loan originators have the capacity to control their 
own compensation based on the terms or conditions offered to consumers, 
the incentive to provide consumers with a higher interest rate or other 
less favorable terms exists. When this unfair practice occurs, it 
results in direct economic harm to consumers whether the loan 
originator is a mortgage broker or employed as a loan officer for a 
bank, credit union, or community bank.
---------------------------------------------------------------------------

    \19\ For example, the FTC's settlement with Gateway Funding, 
Inc. in December 2008 illustrates a case where a creditor's loan 
officers created ``overages,'' although the primary legal theory 
concerned disparate treatment by race in the imposition of overages. 
The FTC's complaint and the court's final judgment and order can be 
found on the FTC's Web site at http://www.ftc.gov/os/caselist/0623063/index.shtm. The FTC has since filed a complaint alleging 
similar patterns of overages in violation of fair lending laws 
against Golden Empire Mortgage, Inc. The May 2009 complaint can be 
found at http://www.ftc.gov/os/caselist/0623061/090511gemcmpt.pdf. A 
similar pattern of overages was alleged in legal actions brought by 
the Department of Justice, which resulted in settlement agreements 
with Huntington Mortgage Company (1995), available at http://www.justice.gov/crt/housing/documents/huntingtonsettle.php, and 
Fleet Mortgage Corp (1996), available at http://www.justice.gov/crt/housing/documents/fleetsettle.php.
---------------------------------------------------------------------------

    The final rule also defines loan originator under Sec.  
226.36(a)(1) as covering both natural persons and mortgage broker 
companies, including those companies that close loans in their own 
names but use table funding from a third party. The final rule 
clarifies that a creditor that funds a transaction is excluded from the 
rule's definition of a loan originator.
    As noted above, a mortgage broker trade group asserted that by 
treating mortgage broker companies that use table funding as ``loan 
originators,'' small brokerage firms that do not fund their own loans 
would be forced out of the marketplace. This commenter argued that 
mortgage brokers benefit consumers by increasing competition in the 
mortgage market and lowering mortgage costs, and cited studies for 
support. One of the studies found that loans obtained through mortgage 
brokers were less costly to borrowers as compared to loans obtained 
through lenders.\20\ Another study noted that mortgage brokers can 
simplify the loan shopping experience for consumers and enhance 
competition.\21\ On the other hand, a consumer group cited studies 
showing that borrowers using mortgage brokers incurred greater costs in 
connection with their loans, such as fees, interest, and other closing 
costs.\22\ This commenter also cited a study that found that broker-
originated loans, as compared to loans originated by creditors' 
employees (loan officers), cost subprime borrowers more in interest 
over the life of the loan.\23\ Although using a broker can help 
consumers shop among different lenders and so enhance competition, 
consumers do not benefit if they are steered by a broker to a higher 
cost loan to increase the broker's compensation.
---------------------------------------------------------------------------

    \20\ Amany El Anshasy, Gregory Elliehausen, & Yoshiaki 
Shimazaki, The Pricing of Subprime Mortgages by Mortgage Brokers and 
Lenders (July 2005).
    \21\ Morris Kleiner & Richard Todd, Mortgage Broker Regulations 
that Matter: Analyzing Earnings, Employment, and Outcomes for 
Consumers, National Bureau of Economic Research Working Paper 13684 
(Dec. 2007).
    \22\ Michael LaCour-Little, The Pricing of Mortgages by Brokers: 
An Agency Problem?, 31 Journal of Real Estate Research 235 (2009); 
Howell E. Jackson & Jeremy Berry, Kickbacks or Compensation: The 
Case of YSPs, 12 Stan. J. L. Bus. & Fin. 298, 353 (2007); Patricia 
A. McCoy, Rethinking Disclosure in a World of Risk-Based Pricing, 44 
Harvard J. on Leg. 123 (2006).
    \23\ Center for Responsible Lending, Steered Wrong: Brokers, 
Borrowers, and Subprime Loans (Apr. 2008).
---------------------------------------------------------------------------

    The Board has considered these comments and believes the studies 
are not dispositive of the issues the rule seeks to address. Brokerage 
entities that do not fund loans out of their own resources operate as 
retail networks for creditors, particularly in markets where creditors 
might not have a direct retail presence. The brokers serve to expand 
the lenders' customer base by bringing loans to creditors that would 
not be originated by the creditors' own employees. In these cases, 
mortgage brokers that do not fund loans do not compete directly with 
creditor entities, but rather with the loan officers of such creditor 
entities. The final rule, as proposed, applies to mortgage brokers, as 
well as employees of creditors, that meet the definition of ``loan 
originator.'' Moreover, as noted above, the rule is intended to address 
uniformly unfair compensation practices that result in consumers being 
given loans with less favorable terms, whether the practices involve 
individual brokers and loan officers or companies that operate as loan 
originators. The Board believes that providing exemptions for any set 
of loan originators would facilitate circumvention of the rule and 
undermine its objective. A rule that covered only natural persons and 
not brokerage entities would permit evasion, for example, by individual 
loan originators incorporating as sole proprietorships.
    In addition, the Board does not believe the final rule will require 
small brokerage firms to go out of business.

[[Page 58518]]

Creditors rely upon mortgage brokers as their retail origination 
network so that they can operate in a greater number of markets with 
less overhead expense than if they operated direct retail branches and 
employed loan officers. To the extent that mortgage brokers provide 
cost savings or other value to creditors as an origination network, the 
final rule does not prevent creditors from compensating these entities 
in a manner that reflects such value, so long as the compensation is 
not based on a transaction's terms or conditions. The Board has 
provided illustrative examples of permissible compensation for loan 
originators in the final rule. The final rule prohibits a particular 
compensation practice that the Board finds to be unfair but does not 
set a cap on the amount of compensation that a loan originator may 
receive. This may result in new business models, but the Board does not 
believe mortgage brokerage firms will no longer be able to compete in 
the marketplace unless they can continue to engage in compensation 
practices the Board has found to be unfair.
    The Board recognizes, however, that including mortgage brokerage 
firms in the definition of ``loan originator'' will capture a 
significant number of small firms; such firms, on average, tend to be 
small (e.g., 7 to 10 employees). In addition, extending the definition 
of ``loan originator'' to entities that function as mortgage brokers in 
particular transactions may also cover community banks and credit 
unions, many of which are small entities. The Board notes that these 
smaller entities may experience relatively higher costs to implement 
the final rule because the costs of compliance are fixed and these 
entities may not achieve similar economies of scale with a smaller loan 
volume. The Board recognizes the concerns of small entities, but 
believes for the reasons stated above that the benefits of the 
prohibition to consumers outweigh the associated compliance costs.
    Furthermore, the definition of ``loan originator'' in Sec.  
226.36(a)(1) is consistent with new TILA Section 103(cc)(2), as enacted 
in Section 1401 of the Reform Act, which defines ``mortgage 
originator'' to include employees of a creditor, individual brokers and 
mortgage brokerage firms, including entities that close loans in their 
own names that are table funded by a third party. Consistent with 
Section 1401 of the Reform Act, the Board does not purport to address 
transactions that occur between creditors and secondary market 
purchasers, to which consumers are not a direct party, and 
appropriately does not extend the rule to compensation earned by 
entities on those transactions.
    Existing Sec.  226.36(a) defining mortgage broker is revised and 
redesignated as new Sec.  226.36(a)(2). Comments 36(a)-1 and -2 
regarding the meaning of loan originator and mortgage broker, 
respectively, are adopted substantially as proposed. However, comment 
36(a)-1 regarding the meaning of loan originator is amended to clarify 
when table funding occurs. For example, a table-funded transaction does 
not occur if a creditor provides the funds for the transaction at 
consummation out of its own resources, such as by drawing on a bona 
fide warehouse line of credit, or out of its deposits. In addition, 
comment 36(a)-1 is also amended to clarify that the definition of 
``loan originator'' 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 only applies to extensions of consumer credit and does 
not apply if a modification of an existing obligation's terms does not 
constitute a refinancing under Sec.  226.20(a).
    Under existing Sec.  226.2(a)(17)(i)(B), a person to whom the 
obligation is initially payable on its face generally is a 
``creditor.'' However, as noted, the definition of ``loan originator'' 
in Sec.  226.36(a)(1) provides that if a creditor closes a loan 
transaction in its own name using table funding by a third party, that 
creditor is also deemed a ``loan originator'' for purposes of Sec.  
226.36. Thus, new comment 36(a)-3 clarifies that for purposes of Sec.  
226.36(d) and (e), the provisions that refer to a ``creditor'' excludes 
those creditors that are also deemed ``loan originators'' under Sec.  
226.36(a)(1) because they table fund the credit transaction (i.e., do 
not provide the funds for the transaction at consummation out of their 
own resources). New comment 36(a)-4 clarifies that for purposes of 
Sec.  226.36, managers, administrative staff, and similar individuals 
whose compensation is not based on whether a particular loan is 
originated are not loan originators.
Covered Transactions
    The Board proposed to apply the prohibitions in Sec. Sec.  
226.36(d) and 226.36(e) to closed-end transactions secured by real 
property or a dwelling regardless of whether they were higher-priced 
loans under existing Sec.  226.35(a). The Board requested comment on 
the relative costs and benefits of applying the rule to all segments of 
the market, whether the costs would outweigh the benefits for loans 
below the higher-priced threshold, and whether the prohibitions should 
be extended to HELOCs.
    Public Comment. Many creditors and their trade associations urged 
the Board to limit the prohibitions in Sec. Sec.  226.36(d) and (e) to 
higher-priced loans. They argued that unfair and abusive practices 
relating to loan originator compensation were historically concentrated 
in the higher-priced loan market. A trade association for independent 
mortgage banking companies also suggested that the rule protect only 
vulnerable consumers that have loans with risky features. In addition, 
most, if not all, industry commenters and their trade groups urged the 
Board to exclude HELOCs from the proposal's coverage. They cited a lack 
of evidence that unfairness is associated with loan originator 
compensation for open-end products.
    In contrast, consumers, consumer advocacy groups, and state 
attorneys general supported extending the prohibitions to the entire 
market, including HELOCs. They stated that the conflict of interest 
inherent in rewarding loan originators for offering less favorable loan 
terms exists regardless of the loan price. They argued that excluding 
HELOCS or loans below the higher-priced threshold from the rules would 
simply result in migration of unfair compensation practices to those 
market segments. Consumer advocates and state attorneys general also 
noted that failure to cover HELOCs would encourage loan originators to 
originate ``piggyback'' HELOCs simultaneously with first-lien loans. 
These commenters claimed that creditors currently offer financial 
incentives to loan originators to originate split loan transactions to 
yield greater return for the creditor, and stated that excluding HELOCs 
from the prohibitions would allow this unfair practice to continue.
    Discussion. The final rule applies to all closed-end consumer 
credit transactions secured by a dwelling, regardless of price or lien 
position. See Sec. Sec.  226.1(c) and 226.3(a), and corresponding 
commentary, regarding extensions of consumer credit subject to TILA. 
The Board believes covering only transactions above the higher-priced 
threshold in Sec.  226.35(a) would fail to protect consumers 
adequately. A consumer can be harmed from a loan originator delivering 
less favorable loan terms or conditions to maximize compensation 
whether the loan has an APR that falls above or below the threshold in 
Sec.  226.35. The Board recognizes that the risk of harm may be lower 
in the prime segment of the market where consumers historically

[[Page 58519]]

have more choices and ability to shop. However, as noted above, the 
Board's consumer testing showed, and anecdotal evidence demonstrates, 
that consumers in all segments of the market fail to appreciate the 
conflict of interest that can arise from originators receiving 
compensation based on the loan terms or conditions offered. As a 
result, the Board believes that consumers in all segments of the market 
are equally susceptible to these unfair compensation practices, and, 
therefore, equally benefit from the prohibition. Moreover, the Reform 
Act provisions on originator compensation are not limited to higher-
priced mortgage loans.
    As discussed above, the Board is adopting this final rule 
consistent with the proposal, and with the definition of ``residential 
mortgage loan'' in the Reform Act. Accordingly, consistent with TILA 
Section 103(cc)(5), as enacted in section 1401 of the Reform Act, the 
final rule excludes HELOCs that are subject to Sec.  226.5b and 
timeshare plans, as described in the Bankruptcy Code, 11 U.S.C. 
101(53D). It also does not apply to loans secured by real property that 
does not include a dwelling. The Board will reconsider these issues in 
connection with future rulemakings to implement the Reform Act and 
assess whether broader coverage is necessary, pursuant to its authority 
in TILA Sections 129(l)(2)(A) and 129B(e).
    Section 226.36(d) currently provides that Sec.  226.36 does not 
apply to HELOCs. Section 226.36(d) is redesignated as Sec.  226.36(f) 
and revised to clarify that all of Sec.  226.36 does not extend to 
HELOCs, and Sec.  226.36(d) and (e) do not extend to a loan that is 
secured by a consumer's interest in a timeshare plan, as described in 
the Bankruptcy Code, 11 U.S.C. 101(53D).\24\ The Board adds new comment 
36-1 to clarify that the final rule on loan origination compensation 
practices covers closed-end consumer credit transactions secured by a 
dwelling or real property that includes a dwelling, including reverse 
mortgages that are not HELOCs, and provides a cross reference to 
additional restrictions set forth in Sec.  226.36(f). In technical 
revisions, the heading to Sec.  226.36 and corresponding commentary is 
revised to reflect the expanded scope of that section, and current 
comment 36-1 is redesignated as comment 36-3. Also in technical 
revisions, Sec. Sec.  226.36(d)(1) and (e), which are discussed in 
detail below, are revised to apply to consumer credit transactions 
secured by a dwelling. In addition, Sec.  226.1(b) is revised to 
reflect that the final rule broadens the scope of Sec.  226.36 from 
transactions secured by the consumer's principal dwelling to all 
transactions secured by real property or a dwelling. Section 
226.1(d)(5) is also revised to reflect the scope of Sec.  226.36.
---------------------------------------------------------------------------

    \24\ In the August 2009 Closed-End Proposal, the Board solicited 
comment on whether Sec. Sec.  226.36(b) and (c) should apply to 
HELOCs. The Board will consider whether to extend Sec. Sec.  
226.36(b) and (c) to HELOCs when it finalizes the August 2009 
Closed-End Proposal.
---------------------------------------------------------------------------

Payments Based on Transaction Terms and Conditions
    As proposed, Sec.  226.36(d)(1) would prohibit any person from 
compensating a loan originator, directly or indirectly, based on the 
terms or conditions of the mortgage. Under the proposal, compensation 
based on the loan amount would have been prohibited as a payment that 
is based on a term of the loan. However, the Board sought comment on an 
alternative that would permit compensation to be based on the amount of 
credit extended, which is a common practice today.
    The prohibition on origination compensation in proposed Sec.  
226.36(d)(1) did not apply to consumers' direct payments to loan 
originators. However, under proposed Sec.  226.36(d)(2), if the 
consumer compensated the loan originator directly, the originator would 
be prohibited from also receiving compensation from the creditor or any 
other person. Proposed Sec.  226.36(d)(3) provided that for purposes of 
the prohibition on certain compensation practices set forth in 
Sec. Sec.  226.36(d)(1) and (d)(2), affiliated entities would be 
treated as a single ``person.'' See Sec.  226.2(a)(22) defining the 
term ``person.''
    The proposed commentary clarified the types of arrangements 
considered to be ``compensation,'' and provided examples of 
compensation based on the transaction's terms or conditions such as 
payments based on the interest rate, and examples of permissible 
methods of compensation to loan originators such as payments based on 
loan volume. The proposed commentary also provided guidance regarding 
pricing flexibility that creditors would retain and the ability to 
adjust loan originator compensation periodically to respond to market 
changes. See comments 36(d)(1)-1 through -6.
    Public Comment. Consumer advocates, associations of state 
regulators, state attorneys general, other Federal banking agencies, 
and members of Congress strongly supported the Board's proposed ban on 
loan originator compensation that is based on the terms or conditions 
of a transaction. They stated that these compensation arrangements lack 
transparency and are unfair and deceptive. They cited various examples 
of the harm caused to consumers and the economy at large by the 
practice of compensating loan originators based on a transaction's 
terms or conditions. These commenters asserted that these compensation 
arrangements led to significant growth of risky loans for non-prime 
consumers, increased mortgage costs, and the foreclosure crisis.
    In contrast, industry commenters and their trade associations 
almost uniformly opposed prohibiting loan originator compensation based 
on the terms or conditions of a transaction. They argued that loan 
originator compensation provides consumers with the option to cover 
upfront costs through the interest rate, and generally makes credit 
more widely available. They further argued that research on the impact 
of loan originator compensation on consumers is inconclusive, and that 
existing regulations under RESPA, the SAFE Act, and the MDIA together 
with market competition are sufficient to protect consumers. 
Independent mortgage companies and their trade groups also asserted 
that the Board should consider adopting less restrictive rules as an 
alternative to the proposal. They also argued that information and 
views received by the Board during the public comment period should be 
set forth in a second proposal to permit further public comment.
    A mortgage broker trade association argued that TILA does not 
authorize the Board to regulate private compensation arrangements 
between employers and employees under TILA. It further asserted that 
the Board did not adequately demonstrate that the proposed rule 
satisfied the FTC standards for unfair or deceptive acts or practices, 
or the rulemaking standards set forth in the Administrative Procedures 
Act (APA).
    The SBA commented that the proposal did not provide sufficient 
information regarding the rule's economic impact on small entities. In 
addition to listing the number and type of affected entities, the SBA 
asserted that the Board should have provided more information about the 
costs of the rule for small entities. The SBA expressed concern that 
small entities that originate loans for creditors would be 
disadvantaged compared to larger entities that are able to fund their 
own loans, because larger entities would be treated as creditors when 
selling loans to secondary market investors. The SBA argued that the 
proposal would require smaller entities to alter their business 
practices and that some small entities might ultimately leave the 
marketplace, making it more difficult for consumers

[[Page 58520]]

to obtain mortgages. The SBA also said the Board should more fully 
consider alternatives that would be less burdensome to small entities 
and reduce or eliminate the economic impact on small entities.
    Discussion. The Board is adopting the prohibition on certain 
compensation practices under Sec.  226.36(d) substantially as proposed, 
except that the final rule permits compensation based on the amount of 
credit extended. In addition, for clarity Sec.  226.36(d)(1) is divided 
into subparts Sec.  226.36(d)(1)(i) through (iii); no other substantive 
change is intended. For the reasons explained in the proposal, the 
Board finds that compensating loan originators based on a loan's terms 
or conditions, other than the amount of credit extended, is an unfair 
practice that causes substantial injury to consumers. The Board is 
taking this action pursuant to its authority under TILA Section 
129(l)(2) to prohibit acts or practices in connection with mortgage 
loans that it finds to be unfair or deceptive.
    As discussed in greater detail above under part VI.C, compensation 
payments based on a loan's terms or conditions create incentives for 
loan originators to provide consumers loans with higher interest rates 
or other less favorable terms, such as prepayment penalties. There is 
substantial evidence that compensation based on loan rate or other 
terms is commonplace throughout the mortgage industry, as reflected in 
Federal agency settlement orders, congressional hearings, studies, and 
public proceedings.\25\ This evidence demonstrates that market forces, 
such as competition or liquidity, have not been adequate to prevent the 
harm to consumers caused by compensation payments that are based on the 
loan's terms or conditions. Creditors' payments to mortgage brokers or 
their own employees are neither transparent nor understood by 
consumers. Accordingly, consumers do not effectively shop or engage in 
negotiation, and instead often rely on the advice of loan originators. 
This reliance further compounds the harmful effect of these unfair 
compensation practices because consumers do not understand that loan 
originators may have the ability to increase the creditor's interest 
rate or include costly terms or features to increase their own 
compensation. The Board's consumer testing conducted in connection with 
the 2008 HOEPA Proposed Rule further demonstrated consumers' reliance 
on loan originators and misunderstanding of loan originator 
compensation. Consequently, these unfair compensation practices cause 
consumers injuries they often cannot reasonably avoid.
---------------------------------------------------------------------------

    \25\ See, e.g., affidavits on loan originator compensation filed 
in Mayor and City Council of Baltimore v. Wells Fargo Bank, N.A., 
Civil No. JFM 1:08 CV-00062, Second Amended Complaint (2010); Iowa 
v. Ameriquest Mortgage Co., et al., Civ. No. CE 53090, Consent Order 
(2006), available at http://www.state.ia.us/government/ag/images/pdfs/Ameriquest_CJ.pdf; Memorandum from Senator Carl Levin and 
Senator Tom Coburn to Members of the Permanent Subcommittee on 
Investigations re: Wall Street and the Financial Crisis: The Role of 
High Risk Home Loans, Exhibit 1a of the Senate Permanent 
Subcommittee on Investigations Hearing on Wall Street and the 
Financial Crisis: The Role of High Risk Home Loans, 4-5 (Apr. 13, 
2010), available at http://hsgac.senate.gov/public/_files/Financial_Crisis/041310Exhibits.pdf; Testimony of Michael C. 
Calhoun, Center for Responsible Lending, Before the U.S. House of 
Representatives Committee on Financial Services, Perspectives on the 
Consumer Financial Protection Agency, 21 (Sept. 30, 2009), available 
at http://www.responsiblelending.org/mortgage-lending/policy-legislation/congress/cfpa-calhoun-testimony.pdf ; Testimony of 
Patricia McCoy, Professor of Law, University of Connecticut Law 
School, Before the U.S. Senate Banking Committee, Consumer 
Protections in Financial Services: Past Problems, Future Solutions, 
8, 10 (Mar. 3, 2009), available at http://banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=40666635-bc76-4d59-9c25-76daf0784239; Susan E. Woodward & Robert E. Hall, Consumer 
Confusion in the Mortgage Market: Evidence of Less than a Perfectly 
Transparent and Competitive Market, American Econ. Rev.: Papers and 
Proceedings (May 2010), available at http://pubs.aeaweb.org/doi/pdfplus/10.1257/aer.100.2.511; Susan Woodward, A Study of Closing 
Costs for FHA Mortgages, HUD Office of Policy Development and 
Research (May 2008); Howell E. Jackson & Jeremy Berry, Kickbacks or 
Compensation: The Case of Yield-Spread Premiums, 12 Stan. J. L, Bus 
& Fin. 289 (2007), available at http://www.law.harvard.edu/faculty/hjackson/pdfs/january_draft.pdf. Most recently, in March 2010 the 
Department of Justice and two subsidiaries of American International 
Group entered into a settlement agreement under which wholesale 
residential mortgages lenders were responsible for broker fee 
disparities. The complaint is available at http://www.justice.gov/crt/housing/documents/aigcomp.pdf, and the consent order can be 
found at http://www.justice.gov/crt/housing/documents/aigsettle.pdf.
---------------------------------------------------------------------------

    The Board has previously considered other less restrictive 
alternatives to address concerns about mortgage originator 
compensation. Under the 2008 HOEPA Proposed Rule, the Board published a 
disclosure-based approach to the problems presented by yield spread 
premiums. For the reasons stated in the August 2009 Closed-End 
Proposal, the Board determined such an approach to be ineffective in 
redressing the harm caused by these unfair compensation practices.
    The Board recognizes that the prohibition on certain compensation 
practices will require entities, both small and large, to alter their 
business practices, develop new business models, re-train staff, and 
reprogram operational systems to ensure compliance with the final rule. 
For the reasons discussed above, the Board believes that the benefits 
to consumers provided by the prohibition on certain unfair compensation 
practices outweigh these associated costs.
    Compensation based on the amount of credit extended. As noted 
above, the Board sought comment on an alternative proposal that would 
permit loan originator compensation to be based on the amount of credit 
extended, which is a common practice today. The Board specifically 
requested comment on whether prohibiting originator compensation based 
on the amount of credit extended to the consumer was unduly restrictive 
and necessary to achieve the purpose of the rule.
    Consumer advocates and certain Federal banking and state regulators 
and elected officials opposed the alternative proposal. They argued 
that it would create an incentive for loan originators to steer 
consumers to larger loans, thereby increasing consumer risk. They 
stated that creditors could find another means to compensate brokers 
and loan officers for additional time spent originating larger loans, 
and suggested that lenders be permitted to set a minimum loan 
origination fee to encourage the origination of small loans. Industry 
commenters and their trade groups strongly supported the alternative 
and stated that payments based on loan amount do not provide harmful 
incentives or result in consumer injury. They asserted that a loan 
originator typically requires compensation in an amount equal to 1 
percent of the loan amount in order to cover the costs of origination. 
Some mortgage industry commenters also recommended permitting 
originators to receive a higher percentage compensation for smaller 
loans to ensure that loan originators receive adequate compensation for 
originating such loans.
    The Board is adopting the alternative as proposed with additional 
clarifications. Under the final rule, the amount of credit extended is 
deemed not to be a transaction term or condition for purposes of Sec.  
226.36(d)(1) provided the compensation payments to loan originators are 
based on a fixed percentage of the amount of credit extended; however, 
such compensation may be subject to a minimum or maximum dollar amount. 
The Board believes that compensation based on the amount of credit 
extended is less subject to manipulation by the originator than 
compensation based on terms such as the interest rate or prepayment 
penalties. For example, a consumer purchasing a home would be unlikely 
to

[[Page 58521]]

accept an offer for a larger loan amount. Furthermore, a loan 
originator's ability to steer consumers to larger loans is limited by 
underwriting criteria such as maximum loan-to-value (LTV) and debt-to-
income (DTI) ratios. The Board notes that transaction amount is 
commonly used throughout the mortgage market to determine the amounts 
paid to other parties, such as real-estate brokers, mortgage insurers, 
and various third-party service providers. The Reform Act also 
specifically permits compensation to loan originators based on the 
amount of credit extended.\26\ For all of the reasons discussed, the 
Board believes prohibiting originator compensation based on the amount 
of credit extended would be unduly restrictive and is unnecessary to 
achieve the purposes of the final rule.
---------------------------------------------------------------------------

    \26\ See TILA Section 129B(c)(1), as enacted in section 1403 of 
the Reform Act.
---------------------------------------------------------------------------

    In response to commenters' concerns that the proposal would provide 
originators with no incentive to originate small loans, the final rule 
explicitly permits creditors to establish minimum or maximum dollar 
amounts for loan originator compensation. To prevent circumvention, the 
commentary clarifies that the minimum or maximum amount may not vary 
with each credit transaction. Thus, a creditor could choose to pay a 
loan originator 1 percent of the amount of credit extended for each 
loan, but no less than $1,000 and no more than $5,000. In this case, 
the originator is guaranteed payment of a minimum amount for each loan, 
regardless of the amount of credit extended to the consumer. Using this 
example, the creditor would pay a loan originator $3,000 on a $300,000 
loan (i.e., 1 percent of the amount of credit extended), $1,000 on a 
$50,000 loan, and $5,000 on a $900,000 loan. However, a creditor may 
not pay a loan originator 1 percent of the amount of credit extended 
for amounts greater than $300,000, and 2 percent of the amount of 
credit extended for amounts that fall between $200,000 and $300,000. In 
addition, the Board notes that creditors are able to use other 
compensation methods to provide adequate compensation for smaller 
loans, such as basing compensation on an hourly rate, or on the number 
of loans originated in a given time period.
    The Board proposed comment 36(d)(1)-10 to clarify that a loan 
originator may be paid the same fixed percentage of the amount of 
credit extended for all transactions, subject to a minimum or maximum 
dollar amount. The Board is adopting the comment, redesignated as 
comment 36(d)(1)-9, substantially as proposed with additional 
clarifications. The revisions clarify that a loan originator may be 
paid compensation based on a fixed percentage that does not vary with 
the amount of credit extended. Thus, a creditor may pay a loan 
originator, for example, 1 percent of the amount of credit extended for 
all loans the originator arranges for the creditor. However, under the 
final rule a creditor may not pay a loan originator a fixed percentage 
that varies with different levels or tiers of amounts. The Board 
believes that permitting compensation to vary in this manner could 
enable evasion of the rule. For example, some creditors might create 
tiers and vary the compensation for each tier so that the tiers serve 
as proxies for other terms or conditions of the transaction. Such a 
rule might also permit creditors to create tiers with minimal 
increments, for instance every $10,000, and increase or decrease the 
percentage of the loan amount paid to the loan originator with each 
tier. The creditor could pair loan terms, such as prepayment penalties, 
with some tiers and not others. In this way, a creditor might evade the 
rule or make enforcement of the prohibition more difficult.
    Unlike compensation based on a fixed percentage of the loan amount, 
underwriting criteria do not serve as a meaningful constraint to the 
loan originator's ability to steer a consumer from one tier to another 
where there are minimal increments between loan tiers. It is also 
unlikely that a consumer would question relatively small differences in 
loan amounts that might move them from one tier to another tier. 
Moreover, if compensation could vary in relation to tiers of loan 
amounts, to prevent potential evasion of the rule, the Board would need 
to determine reasonable increments between tiers and whether the 
percentage paid in relation to tiers could increase, decrease, or both. 
Such an approach would result in an unnecessarily complex rule that 
would make compliance difficult. Furthermore, to the extent that paying 
compensation based on tiered loan amounts is meant to ensure fair 
compensation for some loans and prevent unreasonable compensation for 
others, the Board believes that permitting loan originators to be paid 
a minimum and/or maximum compensation amount serves the same purpose.
    The meaning of the term ``compensation.'' Some commenters were 
concerned that the proposed rule would prevent consumers from choosing 
a higher rate loan to fund amounts that are paid to the originator to 
cover upfront closing costs. The final rule clarifies that this is not 
the case. Under the final rule, a consumer may finance upfront costs, 
such as third-party settlement costs, by increasing or ``buying up'' 
the interest rate regardless of whether the consumer pays the loan 
originator directly or the creditor pays the loan originator's 
compensation. Thus, the final rule does not prohibit creditors or loan 
originators from using the interest rate to cover upfront closing 
costs, as long as any creditor-paid compensation retained by the 
originator does not vary based on the transaction's terms or 
conditions.
    To address commenters' concerns regarding third-party charges, 
comment 36(d)(1)-1 is revised to clarify that for purposes of 
Sec. Sec.  226.36(d) and (e), the term ``compensation'' includes 
amounts retained by the loan originator, but does not include amounts 
that the loan originator receives as payment for bona fide and 
reasonable third-party charges, such as title insurance or appraisals. 
Comment 36(d)(1)-1 provides further clarification for certain 
circumstances where amounts received by the loan originator may exceed 
the third-party's actual charge imposed in connection with the 
transaction but would not be deemed compensation for purposes of 
Sec. Sec.  226.36(d) and (e). The Board recognizes that, in some cases, 
loan originators receive payment for third-party charges that may 
exceed the actual charge because, for example, the loan originator 
cannot determine with accuracy what the actual charge for the third-
party service will be, and, therefore, the originator retains the 
difference. The difference in amount retained by the originator is not 
deemed compensation if the third-party charge imposed on the consumer 
is bona fide and reasonable. On the other hand, if the originator marks 
up the third-party charge (a practice known as ``upcharging'') and 
retains the difference between the actual charge and the marked-up 
charge, the amount retained is compensation for purposes of Sec. Sec.  
226.36(d) and (e).
    Comment 36(d)(1)-1 provides the following example: Assume a loan 
originator charges the consumer a $400 application fee that includes 
$50 for a credit report and $350 for an appraisal. Assume that $50 is 
the amount the creditor pays for the credit report. At the time the 
originator imposes the application fee on the consumer, the originator 
does not know what the actual cost for the appraisal will be, because 
the originator may choose from appraisers that charge between $300 to 
$350 for an appraisal. Later, the cost for the appraisal is determined 
to be $300

[[Page 58522]]

for this consumer's transaction. In this case, the $50 difference 
between the $400 application fee imposed on the consumer and the actual 
$350 cost for the credit report and appraisal is not deemed 
compensation for purposes of Sec. Sec.  226.36(d) and (e), even though 
the $50 is retained by the loan originator. The $50 difference would be 
compensation, however, if the appraisers from whom the originator 
chooses charge fees between $250 and $300.
    The commentary also states that any third-party charge the loan 
originator imposes on the consumer must comply with state and other 
applicable law to be deemed bona fide and reasonable. For example, if a 
loan originator uses an ``average charge,'' to be deemed bona fide and 
reasonable under Sec.  226.36, it must also comply with the provisions 
of HUD's Regulation X, which implements RESPA and addresses the use of 
``average charges.'' See 12 CFR 3500.8(b).
    Comment 36(d)(1)-1 also provides further clarification regarding 
``amounts retained'' by the loan originator that are deemed 
compensation for purposes of Sec. Sec.  226.36(d) and (e). For example, 
if a loan originator imposes a ``processing fee'' on the consumer in 
connection with the transaction and retains such fee, it is deemed 
compensation for purposes of Sec. Sec.  226.36(d) and (e), whether the 
originator expends the time to process the consumer's application or 
uses the fee for other expenses, such as overhead. The remainder of 
comment 36(d)(1)-1 is adopted as proposed, and clarifies that the term 
``compensation'' includes salaries, commissions, and any financial or 
similar incentive that is tied to the transaction's terms or 
conditions, including annual or periodic bonuses, or awards of 
merchandise or other prizes.
    The Board notes that TILA Section 129B(c)(2), as enacted by Section 
1403 of the Reform Act, further restricts a loan originator's ability 
to receive originator compensation from a creditor or other person 
where a consumer makes any upfront payment to the creditor for points 
or fees on the loan, other than certain bona fide third-party charges. 
This restriction was not part of the Board's August 2009 Closed-End 
Proposal. The Board intends to evaluate this issue and implement this 
provision as part of a subsequent rulemaking after giving the public 
notice and opportunity to comment. See also Sec.  226.36(d)(2) 
prohibiting loan originator compensation from dual sources, which is 
discussed below.
    Examples of prohibited compensation. The Board is adopting comment 
36(d)(1)-2 substantially as proposed to provide examples of loan 
originator compensation that are deemed to be based on transaction 
terms or conditions, such as compensation that is based on the interest 
rate, annual percentage rate, or the existence of a prepayment penalty. 
The comment is further revised to provide additional clarification, 
however, regarding credit scores and similar representations of risk.
    As proposed, comment 36(d)(1)-2 stated that a consumer's credit 
score or similar representation of credit risk is not one of the 
transaction's terms and conditions. However, proposed commentary also 
provided that ``a creditor does not necessarily avoid having based a 
loan originator's compensation on the interest rate or the annual 
percentage rate solely because the originator compensation happens to 
vary with the consumer's credit score as well.'' A few commenters 
sought clarification and some urged the Board explicitly to state that 
compensation could be based on credit scores. In contrast, some other 
commenters urged the Board expressly to prohibit basing compensation on 
the credit score or other similar factors of credit risk, such as DTI, 
to prevent possible circumvention of the rule.
    The comment has been revised for clarification. The Board believes 
credit scores or similar indications of credit risk, such as DTI, are 
not terms or conditions of the transaction. At the same time, the Board 
recognizes that they can serve as proxies for a transaction's terms or 
conditions. For example, credit scores are often used by creditors to 
assess a consumer's likelihood of default on a loan. If a creditor 
engages in risk-based pricing, then a lower credit score would yield a 
higher interest rate loan to reflect the greater risk associated with 
extending credit to that consumer, while a higher credit score would 
yield a lower interest rate loan. The Board is concerned that 
permitting compensation to be based on credit score or other similar 
factors that serve as proxies for a transaction's terms or conditions 
would lead to circumvention of the rule. As discussed above, the Board 
believes that the practice of basing compensation on a transaction's 
term or condition leads to consumers being given loans with less 
favorable terms, such as a higher interest rate, which results in harm 
to consumers that they cannot reasonably avoid, and, therefore, 
constitutes an unfair practice. Accordingly, the Board believes that 
permitting compensation based on factors that serve as proxies for a 
transaction's terms or conditions would provide incentives to 
originators to place consumers in loans with less favorable terms, 
which constitutes an unfair practice. Thus, the Board is revising 
comment 36(d)(1)-2 to address these concerns.
    Comment 36(d)(1)-2 clarifies that credit scores or similar 
indications of credit risk, such as DTI, are not terms or conditions of 
the loan. The comment further provides, however, that the rule 
prohibits compensation based on a factor that serves as a proxy for a 
transaction's terms or conditions and provides the following example: 
Assume consumer A and consumer B receive loans from the same loan 
originator and the same creditor. Consumer A has a credit score of 650 
and is given a loan with a 7 percent interest rate, and consumer B has 
a credit score of 800 and is given a loan with a 6\1/2\ percent 
interest rate because of his or her different credit score. If the loan 
originator compensation varies for these transactions in whole or in 
part based on the credit score so that, for instance, the loan 
originator receives $1,500 for the loan given to consumer A and $1,000 
for the loan given to consumer B, compensation would be based on a 
transaction's terms or conditions.
    The clarification in comment 36(d)(1)-2 acknowledges that credit 
scores or similar indications of credit risk may, in some instances, 
serve as proxies for a transaction's terms or conditions, such as the 
interest rate. The Board believes that this clarification is necessary 
to prevent evasion of the rule. The Board emphasizes, however, that the 
final rule does not prohibit risk-based pricing. Risk-based pricing is 
permissible as long as the loan originator's compensation does not vary 
based on the transaction's terms or conditions or factors that serve as 
proxies for the transaction's terms or conditions.
    Some industry commenters argued that originators should receive 
more compensation for loans to borrowers with lower credit scores or 
blemished credit histories, asserting that these borrowers require more 
time and effort of the originator. As discussed, under the final rule 
originators may not receive increased compensation based on credit 
score or credit history, where credit score and credit history serve as 
proxies for loan terms and conditions. The Board notes, however, that 
loan originators may be compensated based on the time actually spent on 
a transaction, as discussed under comment 36(d)-3 below.
    Examples of permissible compensation. Comment 36(d)(1)-3 proposed 
several examples of

[[Page 58523]]

compensation arrangements that would not be based on the transaction's 
terms or conditions, such as loan volume, long-term performance of an 
originator's loans, and time spent. Several commenters suggested, 
however, that the Board provide additional guidance and urged the Board 
to clarify that compensation could be based, for instance, on the 
percentage of transactions successfully originated on behalf of the 
creditor, file quality, and customer satisfaction.
    The Board is adopting comment 36(d)(1)-3 largely as proposed, with 
additional examples of permissible compensation. The comment provides 
that a payment that is fixed in advance for each originated loan and 
compensation that accounts for a loan originator's fixed overhead costs 
are permissible compensation methods. In addition, the comment states 
that a creditor may pay an originator based on the percentage of loan 
applications that result in consummated loans and the quality of the 
loan originator's loan files. The comment also states that compensation 
based on the amount of credit extended is permissible under the rule, 
and provides a cross-reference to comment 36(d)(1)-9 for further 
discussion. The Board believes compensation based on the new examples 
would not provide originators with incentives that are harmful and 
unfair to consumers. The comment clarifies, however, that the examples 
provided in it are illustrative and not exhaustive, and thus a creditor 
may identify and use other permissible compensation methods.
    Compensation that varies from one originator to another. The Board 
further notes creditors may compensate their own loan officers 
differently than mortgage brokers. For instance, to account for the 
fact that mortgage brokers relieve creditors of certain fixed overhead 
costs associated with loan originations, a creditor may pay mortgage 
brokers more than its own retail loan officers. For example, a creditor 
may pay a mortgage broker $2,000 for each loan and pay its loan 
officers $1,500 for each loan. Alternatively, a creditor may pay its 
mortgage brokers an amount equal to 2 percent of the amount of credit 
extended on each loan, and pay its loan officers an amount equal to 1 
percent of the amount of credit extended on each loan. Likewise, a 
creditor may pay one loan officer more than it pays another loan 
officer. For example, a creditor may pay loan officer A an amount equal 
to 1 percent of the amount of credit extended for each loan, and loan 
officer B an amount equal to 1.25 percent of the amount of credit 
extended for each loan. This is permissible, as long as each loan 
originator receives compensation that is not based on the terms or 
conditions of the transactions he or she delivers to the creditor.
    Compensation based on loan volume. The final rule does not prohibit 
a creditor from basing compensation on an originator's loan volume, 
whether by the total dollar amount of credit extended or the total 
number of loans originated over a given time period. These 
arrangements, however, might raise supervisory concerns about whether 
the creditor has created incentives for originators to deliver loans 
without proper regard for the credit risks involved. For example, 
depository institutions and depository institution holding companies 
(banking organizations) are subject to supervisory guidance that 
provides for incentive compensation arrangements to take into account 
credit and other risks in a manner that is consistent with safety and 
soundness practices.\27\ Consistent with this guidance, banking 
organizations should ensure that incentive compensation arrangements 
not only comply with the requirements of TILA, but also do not 
encourage employees to take imprudent risks that are inconsistent with 
the safety and soundness of the organization.
---------------------------------------------------------------------------

    \27\ See Interagency Guidance on Sound Incentive Compensation 
Policies, 75 FR 36395; June 25, 2010.
---------------------------------------------------------------------------

    Compensation based on loan type or program. Some commenters also 
urged the Board to permit higher compensation for certain loan types, 
for example, small loans, loans under special programs that assist 
first-time home-buyers and low- or moderate-income consumers, and loans 
that satisfy the creditor's obligations under the Community 
Reinvestment Act (CRA). As discussed above, creditors can encourage 
originators to make small loans as well as large loans by setting a 
minimum and maximum payment for each loan if they compensate loan 
originators a fixed percentage of the amount of credit extended. See 
comment 36(d)(1)-9. The Board believes, however, that allowing 
compensation to vary with loan type, such as loans eligible for 
consideration under the CRA, would permit unfair compensation practices 
to persist in loan programs offered to consumers who may be more 
vulnerable to such practices.
    Compensation that differs based on geography. Proposed comment 
36(d)(1)-4 clarified that payment of compensation to a loan originator 
that differed by geographical area was not prohibited under the 
proposal, provided that such compensation arrangements complied with 
other applicable laws such as the Equal Credit Opportunity Act (15 
U.S.C. 1691-1691f) and Fair Housing Act (42 U.S.C. 3601-3619). One 
commenter noted that significant differences exist in geographic areas 
that can impact loan terms and conditions, such as property value or 
ranges of income. This commenter urged the Board expressly to provide 
that creditors can structure originator compensation to account for 
geographical differences. Other industry commenters also generally 
suggested that the Board permit compensation to vary based on 
identified market and geographical factors, in addition to other 
factors such as charter type and institution size.
    The Board is not adopting comment 36(d)(1)-4, and is redesignating 
36(d)(1)-5 through 36(d)(1)-10 accordingly. Comment 36(d)(1)-4 was 
intended to clarify that compensation may take account of differences 
in the costs of loan origination, such as rent and other overhead 
expenses. As discussed above, however, the Board has clarified under 
comment 36(d)(1)-2 that compensation paid to loan originators may 
account for differences in the costs of origination such as fixed 
overhead costs, and believes this example is sufficient to address the 
matter. The Board notes that any compensation arrangement must also 
comply with all other applicable laws, such as the Equal Credit 
Opportunity Act and the Fair Housing Act.
    Creditors' pricing flexibility. Consumer advocates argued that the 
Board should only permit loan originators to receive yield spread 
premiums on ``no-cost'' loans, meaning loans for which the interest 
rate is high enough to eliminate all of the consumer's upfront costs 
including points and third party closing costs. Consumer advocates 
asserted that when an originator receives a yield spread premium and 
the consumer pays some or all of the other closing costs upfront, the 
consumer is more susceptible to being over-charged because he or she 
does not understand the trade-off between upfront closing costs and 
higher interest rates. Therefore, these commenters argued that the rule 
should prohibit a yield spread premium and upfront charges on the same 
transaction.
    The Board is not adopting the recommendation to limit compensation 
paid to loan originators through the rate to no-cost loans. 
Accordingly, the Board is adopting comment 36(d)(1)-5, redesignated as 
comment 36(d)(1)-4, as proposed to clarify that the rule does

[[Page 58524]]

not affect creditors' flexibility in setting rates or other loan terms. 
The Board recognizes that some research has suggested that consumers 
who received no-cost loans paid less for their loans than consumers who 
received loans where they paid some upfront charges and a yield spread 
premium.\28\ The Board's proposal did not restrict yield spread 
premiums to no-cost loans, however, and therefore the recommendation is 
outside the scope of the proposed rule. Provisions of the Reform Act 
address this issue, which will be the subject of a future rulemaking.
---------------------------------------------------------------------------

    \28\ See, e.g., Susan E. Woodward & Robert E. Hall, Consumer 
Confusion in the Mortgage Market: Evidence of Less than a Perfectly 
Transparent and Competitive Market, 513-15, American Econ. Rev.: 
Papers and Proceedings (May 2010), available at http://pubs.aeaweb.org/doi/pdfplus/10.1257/aer.100.2.511; Susan Woodward, A 
Study of Closing Costs for FHA Mortgages, HUD Office of Policy 
Development and Research (May 2008).
---------------------------------------------------------------------------

    In addition, under the rule, creditors may adjust the loan terms it 
offers to consumers to finance transaction costs the consumer would 
otherwise be obligated to pay directly in cash or out of the loan 
proceeds. For example, a creditor could recoup some costs related to 
the loan transaction by adding an origination point to the loan terms 
(calculated as one percentage point of the loan amount). However, any 
adjustment of loan terms must not affect the amount a loan originator 
receives as compensation for the transaction. Thus, the final rule does 
not impact creditors' ability to offer a full range of interest rate 
and fee combinations, so long as the exchange between the loan price 
and transaction costs has no bearing on loan originator compensation. 
For example, a creditor could add a constant premium of \1/4\ of one 
percent to the interest rates on all transactions to recoup loan 
originator compensation. See comment 36(d)(1)-5.
    Effect of modification of loan terms. Under the proposed rule, a 
loan originator's compensation could neither be increased nor decreased 
based on the loan terms and conditions. Accordingly, proposed comment 
36(d)(1)-6 clarified that if a consumer's request for a lower rate was 
accepted by the creditor, the creditor would not be permitted to reduce 
the amount it pays to the loan originator based on the change in loan 
terms. Similarly, any reduction in origination points paid by the 
consumer would be a cost borne by the creditor.
    Industry commenters opposed prohibiting creditors from reducing 
loan originator compensation when the loan originator offers a 
favorable loan term change to a consumer. They argued that unusual 
circumstances require flexibility, and that loan term concessions help 
consumers receive better loans. They further stated that fair lending 
laws adequately provide protection from unlawful discrimination in 
offering more favorable terms on a prohibited basis.
    For the reasons explained in the proposal, the Board is adopting 
comment 36(d)(1)-6, redesignated as comment 36(d)(1)-5, as proposed. 
The Board believes that permitting creditors to decrease loan 
originator compensation because of a change in terms favorable to the 
consumer would result in loopholes and permit evasions of the final 
rule. For example, a creditor could agree to set originators' 
compensation at a high level generally, and then subsequently lower the 
compensation in selective cases based on the actual loan terms, such as 
when the consumer obtains another offer with a lower interest rate. 
This would have the same effect as increasing the originator's 
compensation for higher rate loans. As noted above, the Board believes 
such compensation practices are harmful and unfair to consumers.
    Thus, under the final rule, when the creditor offers to extend a 
loan with specified terms and conditions (such as rate and points), the 
amount of the originator's compensation for that transaction is not 
subject to change, based on either an increase or a decrease in the 
consumer's loan cost or any other change in the loan terms. The Board 
recognizes that in some cases a creditor may be unable to offer the 
consumer a lower cost and more competitively-priced loan without also 
reducing the creditor's own origination costs. Creditors finding 
themselves in this situation frequently, however, will be able to 
adjust their pricing and compensation arrangements to be more 
competitive with other creditors in the market.
    Periodic changes in loan originator compensation. The Board 
proposed comment 36(d)(1)-7 to provide guidance on how creditors may 
periodically revise the compensation they pay a loan originator without 
violating the rule. The Board is adopting the comment, redesignated as 
comment 36(d)(1)-6, as proposed. The revised compensation arrangement 
must result in payments to the loan originator that are not based on 
the terms or conditions of a transaction. Thus, a creditor may 
periodically review factors such as loan performance, loan volume, and 
current market conditions for originator compensation, and 
prospectively revise the compensation it will pay the loan originator 
for future transactions.
    Compensation received directly from the consumer. The Board 
proposed comment 36(d)(1)-8 to indicate that the prohibition in Sec.  
226.36(d)(1) did not apply to transactions in which the loan originator 
received compensation directly from the consumer, and to clarify that 
in such cases no other person could pay the loan originator in 
connection with the particular transaction pursuant to Sec.  
226.36(d)(2). See Sec.  226.36(d)(2) and corresponding commentary below 
discussing the prohibition on compensation from both the consumer and 
another source. Proposed comment 36(d)(1)-8 also provided guidance 
regarding what constitutes compensation received directly from the 
consumer.
    The Board is adopting the comment, redesignated as comment 
36(d)(1)-7, substantially as proposed with clarifications. Comment 
36(d)(1)-7 provides that loan originator compensation may be paid 
directly by the consumer whether it is paid in cash or out of the loan 
proceeds. However, payments by the creditor to the loan originator that 
are derived from an increased interest rate are not considered 
compensation received directly from the consumer. Comment 36(d)(1)-7 
further clarifies that origination points charged by a creditor are not 
compensation paid directly by a consumer to a loan originator whether 
they are paid in cash or out of loan proceeds. If a creditor pays 
compensation to the loan originator out of points, the loan originator 
may not also collect compensation directly from the consumer. To 
facilitate compliance, comment 36(d)(1)-7 provides a cross reference to 
36(d)(1)-1, which discusses compensation.
Prohibition of Compensation From Both the Consumer and Another Source
    The Board proposed Sec.  226.36(d)(2) to provide that, if a loan 
originator is compensated directly by the consumer on a transaction, no 
other person may pay any compensation to the originator for that 
transaction. Direct compensation paid by a consumer to a loan 
originator is not limited to ``origination fees,'' ``broker fees,'' or 
similarly labeled charges. Rather, compensation for this purpose 
includes any payment by the consumer that is retained by the loan 
originator. Thus, a creditor that is a loan originator by virtue of 
making a table-funded transaction is subject to this prohibition if it 
imposes and retains any direct charge on the consumer for the 
transaction. See comment 36(d)(1)-1 for further discussion of amounts 
retained by a loan originator for bona fide third-

[[Page 58525]]

party charges that are and are not deemed compensation.
    Industry commenters and their trade associations opposed the 
proposed restriction on loan originator compensation from more than one 
source. These commenters argued that the proposed rule would give 
consumers fewer options for paying closing costs, including broker 
compensation. Some commenters recommended permitting loan originators 
to receive payments from both a creditor and a consumer if the total 
compensation does not exceed an agreed-upon amount and is reasonable. 
For example, a trade association suggested that reasonable compensation 
would not exceed 2 percent of the loan amount, subject to minimum of 
$500.
    On the other hand, consumer advocates and a Federal banking agency 
urged the Board to adopt Sec.  226.36(d)(2) as proposed. Consumer 
advocates asserted that allowing loan originators to receive 
compensation from different sources would enable loan originators to 
evade the prohibition on loan originator compensation based on the 
terms and conditions of a transaction. Consumer advocates concurred 
with the rationale stated in the Board's proposal, that consumers may 
reasonably believe that their direct payments are the only compensation 
the loan originator receives. They stated that consumers generally are 
less able to keep track of points paid on a loan and of the total 
amount of originator compensation paid, when loan originators receive 
compensation from multiple sources.
    The Board is adopting Sec.  226.36(d)(2) as proposed with some 
clarifications. The Board believes this provision is necessary to 
ensure that the protections in Sec.  226.36(d)(1) are effective and 
that loan originators do not increase a consumer's interest rate or 
points to increase the originator's own compensation. Allowing the 
originator to receive compensation directly from the consumer while 
also accepting payment from the creditor in the form of a yield spread 
premium would enable the originator to evade the prohibition in Sec.  
226.36(d)(1). An originator that increases the consumer's interest rate 
to generate a larger yield spread premium can apply the excess creditor 
payment to third-party closing costs and thereby reduce the amount of 
consumer funds needed to cover upfront fees. Without Sec.  
226.36(d)(2), the originator could then impose a direct fee on the 
consumer in the same amount, to retain the benefit of the larger yield 
spread premium.
    For example, suppose that for a loan with a 5 percent interest 
rate, the originator will receive a payment of $1,000 from the creditor 
as compensation, and for a loan with a 6 percent interest rate, a yield 
spread premium of $3,000 will be generated. Under Sec.  226.36(d)(1), 
the originator must apply the additional $2,000 to cover the consumer's 
other closing costs. Without Sec.  226.36(d)(2), instead of reducing 
the consumer's total upfront payment, the originator could also impose 
a $2,000 origination fee directly on the consumer, essentially 
retaining the benefit of the larger yield spread premium.
    As discussed above, consumers generally are not aware of creditor 
payments to originators and reasonably may believe that when they pay a 
loan originator directly, that amount is the only compensation the loan 
originator will receive. Even if a consumer were aware of such creditor 
payments to loan originators, the consumer could reasonably expect that 
making a direct payment to an originator would reduce or eliminate the 
need for the creditor to fund the originator's compensation through the 
consumer's interest rate. Because yield spread premiums are not 
transparent to consumers, however, consumers cannot effectively 
negotiate the originator's compensation. In fact, if consumers pay loan 
originators directly and creditors also pay originators through higher 
rates, consumers may be injured by unwittingly paying originators more 
in total compensation (directly and through the rate) than consumers 
believe they agreed to pay.
    The Board does not believe that Sec.  226.36(d)(2) will 
significantly limit consumer choice, as consumers may still use a rate 
increase to cover upfront closing costs that are charged by third 
parties, as long as loan originators receive their compensation from 
only one party. Section 226.36(d)(2) will, however, increase 
transparency for consumers by reducing the total number of loan pricing 
variables with which consumers must contend. The increased transparency 
is consistent with TILA's purpose of promoting the informed use of 
consumer credit.\29\ See TILA Section 102(a), 15 U.S.C. 1601(a). 
Consistent with TILA Section 129B(c)(2), as enacted in section 1403 of 
the Reform Act, the final rule permits loan originators to receive 
payment from a person other than the consumer only if the originator 
does not also receive any compensation directly from the consumer. As 
noted above, TILA Section 129B(c)(2) further restricts a loan 
originator's ability to receive compensation from a person other than a 
consumer where a consumer pays upfront points or fees on the 
transaction, other than certain bona fide third-party charges. See 
comment 36(d)(1)-1 discussing the term ``compensation.'' The Board 
intends to address this issue as part of a subsequent rulemaking after 
giving the public notice and opportunity to comment.
---------------------------------------------------------------------------

    \29\ See, e.g., Susan E. Woodward, A Study of Closing Costs for 
FHA Mortgages 70-73, Urban Institute and U.S. Department of Housing 
and Urban Development (2008), available at http://www.urban.org/UploadedPDF/411682_fha_mortgages.pdf.
---------------------------------------------------------------------------

    The Board is also adopting comment 36(d)(2)-1 substantially as 
proposed with some clarifications. Comment 36(d)(2)-1 clarifies 
circumstances when a person is or is not deemed to provide compensation 
to a loan originator in connection with a particular credit 
transaction. Comment 36(d)(2)-1 explains that payment of a salary or 
hourly wage to a loan originator does not violate the prohibition in 
Sec.  226.36(d)(2) even if the loan originator also receives direct 
compensation from a consumer in connection with that consumer's 
transaction. However, the final rule also clarifies that, in this 
instance, if any loan originator receives compensation directly from 
the consumer in connection with a specific credit transaction, no other 
loan originator, such as the mortgage broker company or another 
employee of the mortgage broker company, can receive compensation from 
the creditor in connection with that particular credit transaction.
    The Board proposed in comment 36(d)(2)-2 to clarify that yield 
spread premiums, even if disclosed as ``credits'' in accordance with 
HUD's Regulation X, which implements RESPA, are not considered 
compensation received by the loan originator directly from the consumer 
for purposes of this rule. Under Regulation X, a yield spread premium 
paid by a creditor to the loan originator may be characterized on the 
RESPA disclosures as a ``credit'' that will be applied to reduce the 
consumer's total settlement charges, including origination fees. A 
mortgage broker trade association opposed the clarification in proposed 
comment 36(d)(2)-2 and urged the Board to treat yield spread premiums 
as payments made directly from the consumer to the loan originator 
under Regulation Z. By contrast, as discussed above, consumer advocates 
and a Federal banking agency urged the Board to adopt Sec.  
226.36(d)(2) as proposed.
    The Board is adopting comment 36(d)(2)-2, as proposed. If the rule 
were to treat yield spread premiums as payments made directly by the 
consumer, loan originators could accept

[[Page 58526]]

both a yield spread premium from the creditor as well as a payment from 
the consumer, which would undermine the purpose of the rule. For the 
reasons stated above, the Board believes that permitting compensation 
from different sources would enable originators to evade the 
prohibition on receiving compensation based on the loan terms and 
conditions. Comment 36(d)(2)-2 clarifies that for purposes of this 
final rule, payments made by creditors to loan originators are not 
payments made directly by the consumer, regardless of how they might be 
disclosed under HUD's Regulation X.
Affiliated Entities
    The Board is adopting the definition of ``affiliates'' under Sec.  
226.36(d)(3), as proposed with some clarifications. Section 
226.36(d)(3) clarifies that affiliates must be treated as a single 
``person'' for purposes of Sec.  226.36(d), and comment 36(d)(3)-1 
provides a cross-reference to the definition of ``affiliates'' in Sec.  
226.32(b)(2). Commenters did not address this aspect of the proposed 
rule. The Board believes that defining the term ``affiliates'' as a 
single person for purposes of Sec.  226.36(d) is necessary to prevent 
circumvention of the final rule. For example, circumvention would occur 
if a parent company with multiple subsidiaries could structure its 
business to evade the prohibition on certain compensation practices. To 
illustrate, the rule would be circumvented if a parent company that has 
two mortgage lending subsidiaries could arrange to pay a loan 
originator greater compensation on higher rate loans offered by 
subsidiary ``A'' than the compensation it would pay the same originator 
for a lower rate loan made by subsidiary ``B.'' To address this issue, 
the Board treats such subsidiaries of the parent company as a single 
person, so that if a loan originator is able to deliver loans to both 
subsidiaries, they must compensate the loan originator in the same 
manner. Accordingly, if a loan originator delivers a loan to subsidiary 
``B'' and the interest rate is 8 percent, the originator must receive 
the same compensation that would have been paid by subsidiary ``A'' for 
a loan with a rate of either 7 or 8 percent. The Board is also adopting 
comment 36(d)(3)-1, as proposed.
Record Retention Requirements
    Currently, creditors are required by Sec.  226.25(a) to retain 
evidence of compliance with Regulation Z for two years. Under the 
proposal, comment 25(a)-5 clarified that a creditor must retain at 
least two types of records to demonstrate compliance with Sec.  
226.36(d)(1): A record of the compensation agreement with the loan 
originator that was in effect on the date the transaction's rate was 
set, and a record of the actual amount of compensation it paid to a 
loan originator in connection with each covered transaction. The 
proposed comment explained that for loans involving mortgage brokers, 
the creditor may retain the HUD-1 settlement statement required under 
RESPA as a record of the actual amount of loan originator compensation 
paid. The Board sought comment on whether other records should be 
subject to the retention requirements; whether some time other than the 
date the transaction rate is set would be more appropriate; whether the 
two-year retention requirement was adequate; and the relative costs and 
benefits of requiring persons, other than creditors, to retain records 
concerning originator compensation.
    Industry commenters and their trade associations opposed expanding 
the record retention requirements to persons other than creditors, 
citing cost and burden as reasons. A credit union trade association 
affirmed that systems currently used by credit unions to track loan 
originator compensation should be deemed sufficient. This commenter 
also stated that credit union compensation records indicating that loan 
originator compensation was provided in the form of salary without 
being directly attributable to a particular transaction should satisfy 
the record retention requirements.
    Associations of state regulators urged the Board to require the 
retention of records for longer than two years. Consumer advocates 
recommended that the Board require retention of records by all parties 
making payments to loan originators for five years. They asserted that 
detection of violations of the rule would be unlikely within the two-
year period. These commenters also noted that that the HUD-1 settlement 
statement is often inaccurate, and so should not be considered a record 
of the actual amount of loan originator compensation paid, but did not 
offer other alternatives.
    The Board is adopting comment 25(a)-5 substantially as proposed. 
Accordingly, the final rule does not extend the record retention 
requirement to persons other than the creditor that pays loan 
originator compensation. At the time the Board issued this proposal and 
comments were submitted, TILA did not subject non-creditors to civil 
liability. As a result, the comments did not take into account such 
liability in their analysis of the costs and benefits of recordkeeping 
by non-creditors. On July 21, 2010, Congress enacted the Reform Act, 
which amended TILA to provide civil liability for loan originators.\30\ 
The Board will request additional comment on this matter in connection 
with subsequent rulemakings to implement provisions of the Reform Act.
---------------------------------------------------------------------------

    \30\ See TILA Section 129B(d), as enacted in Section 1404 of the 
Reform Act.
---------------------------------------------------------------------------

    Under the final rule, any creditor who pays loan originator 
compensation, and, therefore, is subject to Sec.  226.36(d), is 
required to retain records pursuant to Sec.  226.25(a). The Board 
believes record retention requirements are necessary to ensure that the 
loan originator compensation rules in Sec. Sec.  226.36(d) and (e) are 
enforceable. Comment 25(a)-5 is being revised to remove reference to 
the HUD-1 settlement statement which does not currently itemize loan 
originator compensation. Comment 25(a)-5 is also revised to provide 
that where a loan originator is a mortgage broker, a disclosure or 
agreement required by applicable state law that complies with Sec.  
226.25 is presumed to be a record of the amount actually paid to the 
loan originator in connection with the transaction.
    The final rule does not extend the record retention requirement for 
origination compensation beyond two years. This is the same time period 
that applies for records of compliance with other provisions of 
Regulation Z. The Board weighed the potential benefits of a longer 
timeframe against the increased costs, and believes that the benefits 
of a longer time period do not clearly outweigh the costs. To 
facilitate compliance, the Board adopts proposed comment 36(d)(1)-9, 
redesignated as comment 36(d)(1)-8, to provide a cross-reference to the 
record retention requirement.
Alternatives and Exemptions Not Adopted
    Disclosures. Industry commenters and their trade associations urged 
the Board to implement disclosure requirements to address unfair 
compensation practices, instead of directly prohibiting loan originator 
compensation based on terms or conditions of the transaction under 
Sec.  226.36(d)(1). In particular, the SBA and a mortgage broker trade 
association recommended that the Board replace the proposed prohibition 
on certain compensation practices with a requirement that creditors 
disclose the lowest interest rate they would accept for a given loan. A 
Federal banking agency suggested that, in addition to prohibiting loan 
originator

[[Page 58527]]

compensation based on the terms or conditions of a transaction, the 
Board develop and require uniform mortgage broker disclosures that 
specify the mortgage broker's role and fees. This commenter argued that 
such disclosures would help consumers understand the role of brokers, 
and would indirectly reform loan originator compensation practices.
    For the reasons discussed in the proposal, the Board is not 
adopting disclosure requirements as an alternative to the proposed 
prohibitions on certain compensation practices. In connection with its 
proposal of a disclosure-based approach to originator compensation, the 
Board conducted consumer testing of the disclosures and based on the 
results of such testing, and other concerns, withdrew the rule in its 
2008 HOEPA Final Rule. For the reasons stated therein and reiterated in 
its August 2009 Closed-End Proposal, the Board believed that disclosure 
of loan originator compensation would not address the injury to 
consumers. The Board was concerned that after reading the disclosures 
consumers often concluded, not necessarily correctly, that mortgage 
brokers are more expensive than creditors. Many consumers also believed 
that mortgage brokers would serve their best interests notwithstanding 
disclosure of the conflict of interest resulting from the relationship 
between interest rates and broker compensation.
    The Board's consumer testing also suggests that few consumers shop 
for mortgages, and often rely on one broker or lender because of their 
trust in the relationship, and because they do not know that brokers 
and lenders have discretion over the loan terms offered. Moreover, even 
when originator compensation is disclosed, consumers typically do not 
understand its complexities or how it relates to the mechanics of loan 
pricing. Consumers do not understand how a creditor payment to a loan 
originator can result in a higher interest rate for consumers. Without 
that knowledge, consumers cannot take steps to protect their own 
interests, for example by negotiating for a smaller direct payment, a 
lower rate, or both.
    Further, HUD and some states have required certain disclosures of 
mortgage broker fees for years. In spite of these disclosures, concerns 
continue to be raised about abuses associated with yield spread 
premiums and similar compensation for loan officers. For these reasons, 
the Board believes that disclosures are ineffective at addressing 
unfair originator compensation.
    Caps. Some industry commenters and trade associations recommended 
the Board adopt a cap on loan originator compensation, for example at 
two percent of the loan amount, while allowing compensation to vary 
from transaction to transaction based on the loan's terms. The Board is 
not imposing a cap on the amount of loan originator compensation that 
can be paid in a particular transaction. Although a cap might prohibit 
the most egregious compensation practices, it would not adequately 
address the consumer injury that the final rule is designed to address. 
A cap would merely create an upper limit on an originator's 
compensation; it would not prevent a loan originator from increasing 
the consumer's rate or points to increase the originator's own 
compensation. In addition, a cap would require the Board to determine 
an upper limit that is appropriate for all loans. It is unclear how, or 
on what basis, the Board would determine the appropriate cap for all 
loans, and, therefore, such a cap might prove arbitrary. In some cases 
originators might not be fully compensated for their work, and in other 
cases they might receive compensation that exceeds the value of their 
services. Some loan originators would simply charge up to the cap in 
all cases. For all of these reasons, the final rule does not apply a 
cap to originator compensation.
Prohibition on Steering
    The Board requested comment on a proposal under Sec.  226.36(e)(1) 
that would prohibit loan originators from directing or ``steering'' 
consumers to loans based on the fact that the originator will receive 
additional compensation, when that loan may not be in the consumer's 
interest. The proposed rule was intended to prevent circumvention of 
the prohibition in Sec.  226.36(d)(1), which could occur if the loan 
originator steered the consumer to a loan with a higher interest rate 
or higher points to increase the originator's compensation. To 
facilitate compliance with this anti-steering rule, the Board also 
proposed a safe harbor in Sec. Sec.  226.36(e)(2) and (3). Under the 
safe harbor, a loan originator would be deemed to comply with the anti-
steering rule if, under certain specified conditions, the consumer is 
presented with a choice of loan options that include (1) the lowest 
interest rate, (2) the second lowest interest rate, and (3) the lowest 
total dollar amount for origination points or fees and discount points. 
Proposed commentary provided additional guidance regarding the 
prohibition on steering and the safe harbor.
    The Board specifically sought comment on whether the steering 
prohibition would be effective in achieving its stated purpose, as well 
as the feasibility and practicality of such a rule, its enforceability, 
and any unintended adverse effects the rule might have. As discussed in 
further detail below, the Board is adopting the anti-steering rule 
under Sec.  226.36(e)(1) as proposed, with a modification to the safe 
harbor provided under Sec. Sec.  226.36(e)(2) and (3).
    Public Comment. Industry commenters and their trade associations 
generally asserted that the anti-steering prohibition, as well as the 
safe harbor, were too vague and would increase compliance costs and 
litigation risk. They asserted that these costs would, in turn, be 
passed on to consumers. Some commenters argued that the anti-steering 
rule would interfere with the loan originator's ability to communicate 
with consumers. They claimed that the prohibition would cause loan 
originators not to advise their consumers fully about possible loan 
options. These commenters urged the Board to provide a safe harbor for 
various disclosures instead of the anti-steering rule.\31\ A credit 
union trade association suggested a safe harbor for consumers who know 
what loan type they want, and for smaller entities that may offer only 
one or two types of loans.
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    \31\ A mortgage broker trade association suggested that the 
Board look to a House-passed bill that preceded the Reform Act for 
guidance on its anti-steering rule. For the reasons discussed above, 
the Board's rule is consistent with the Reform Act as enacted.
---------------------------------------------------------------------------

    Consumer advocates, other Federal banking agencies, members of 
Congress, and state officials generally supported the anti-steering 
proposal, although some noted concerns with the safe harbor and 
associated record-keeping requirements. These commenters stated that 
the practice of steering consumers to loans with less favorable terms 
increases consumers' costs and risk, increases the risk to the market 
as a whole, and has the potential to result in illegal discrimination. 
For example, one commenter stated that originator compensation led to 
many borrowers who qualified for prime loans being steered to subprime 
loans. This commenter also asserted that the compensation practices 
addressed by the rule caused subprime borrowers to have reduced access 
to loans with lower interest rates and no risky features, and 
contributed significantly to foreclosures in minority neighborhoods.
    With respect to the safe harbor, consumer advocates, state 
officials, and

[[Page 58528]]

a Federal banking agency expressed concern that the proposed safe 
harbor would undermine the effectiveness of the prohibition on certain 
compensation payments under Sec.  226.36(d). These commenters stated 
that the safe harbor was too broad and would permit circumvention of 
the rule under Sec.  226.36(d)(1). They argued that the safe harbor 
would create incentives for ``pro forma'' compliance, and weaken 
consumers' access to effective remedies. These commenters urged the 
Board to eliminate the safe harbor entirely so that compliance with the 
steering prohibition could be determined case-by-case, based on whether 
the loan originator could have offered the consumer a loan transaction 
with lower costs. Alternatively, they recommended that the Board 
replace the safe harbor with a rebuttable presumption of compliance 
that would only be available in those instances where the loan 
originator offered, and the consumer chose, a ``plain vanilla loan'' 
(e.g., a loan with a rate that is fixed for at least 5 years with a 
competitive interest rate, points and fees equal to 2 points or less, 
no prepayment penalty, fully amortizing payments, and that is 
underwritten with full documentation of the consumer's ability to 
repay).
    Discussion. The Board is adopting the anti-steering rule under 
Sec.  226.36(e)(1) as proposed, with some clarifications to 
corresponding comments 36(e)(1)-1 through -3. The Board believes an 
anti-steering rule is appropriate and necessary to prevent the harm 
that results if loan originators steer consumers to a particular 
transaction based on the amount of compensation paid to the originator 
when that loan is not in the consumer's interest. In addition, the 
Board believes the rule is necessary to prevent circumvention of the 
prohibition in Sec.  226.36(d)(1). Section 226.36(d)(1) does not 
prevent a loan originator from directing a consumer to transactions 
from a single creditor that offer greater compensation to the 
originator, while ignoring possible transactions having lower interest 
rates that are available from other creditors. Consumers generally are 
unaware of yield spread premiums and are unable to appreciate the 
incentives such compensation creates regarding the loan options a loan 
originator may choose to present to consumers. Unaware of these 
financial incentives, consumers are unable to engage in effective 
negotiation with loan originators. Rather, consumers are more likely to 
rely on a loan originator's advice regarding which loan transaction 
will be in their interest. Consequently, these consumers may pay more 
for mortgage credit than they would otherwise be required to pay. As 
discussed above in part VI.C, the Board finds such a practice to be 
unfair.
    The final rule under Sec.  226.36(e)(1) prohibits loan originators 
from directing or ``steering'' a consumer to consummate a dwelling-
secured loan based on the fact that the originator will receive greater 
compensation from the creditor in that transaction than in other 
transactions the originator offered or could have offered to the 
consumer, unless the consummated transaction is in the consumer's 
interest. The rule is intended to preserve consumer choice by ensuring 
that consumers have loan options that reflect considerations other than 
the maximum amount of compensation that will be paid to the originator. 
Thus, originators could violate the anti-steering prohibition if, for 
instance, they direct a consumer to a fixed-rate loan option from a 
creditor that maximizes the originator's compensation without providing 
the consumer with an opportunity to choose from other available loans 
that have lower fixed interest rates with the equivalent amount in 
origination and discount points.
    Commenters expressed concern that a prohibition on steering could 
negatively impact the relationship between loan originators and 
consumers, for example by causing loan originators not fully to advise 
consumers on available loan options. The Board believes, however, that 
the anti-steering rule is sufficiently flexible to allow the loan 
originator and consumer to continue to discuss and determine which 
terms and conditions of the loan transaction, in addition to other 
factors such as length of time until closing, will serve the consumer's 
interest. For example, comment 36(e)(1)-2(ii) makes clear that the 
final rule does not require a loan originator to direct a consumer to 
consummate the transaction that will result in the least amount of 
compensation being paid to the originator by the creditor. However, if 
the loan originator reviews possible loan offers available from a 
significant number of the creditors with which the originator regularly 
does business, and the originator directs the consumer to the 
transaction that will result in the least amount of creditor-paid 
compensation, the requirements of Sec.  226.36(e) would be deemed to be 
satisfied.
    Comment 36(e)(1)-2 is also revised to provide additional 
clarification that where a loan originator directs a consumer to a 
transaction that will result in a greater amount of creditor-paid 
compensation for the loan originator, Sec.  226.36(e)(1) is not 
violated if the terms and conditions on that transaction are the same 
as other possible loan offers available through the originator, and for 
which the consumer likely qualifies. Comment 36(e)-1 is adopted as 
proposed to provide guidance on compensation that is subject to the 
anti-steering rule. Comments 36(e)(1)-1 and -3 are adopted as proposed 
to provide further guidance regarding what it means to ``direct'' or 
``steer'' a consumer, and examples of conduct that is prohibited under 
the anti-steering rule, respectively.
    As discussed above under the definition of a ``loan originator,'' 
employees of a creditor are prohibited under Sec.  226.36(d)(1) from 
receiving compensation that is based on the terms or conditions of the 
loan. Thus, when originating loans for the employer-creditor, the 
originator may not steer the consumer to a particular loan offered by 
the employer to increase compensation. Accordingly, in these cases, 
compliance with Sec.  226.36(d)(1) is deemed to satisfy the 
requirements of Sec.  226.36(e)(1). At the same time, the Board 
recognizes that a creditor's employee may occasionally act as a broker 
by forwarding a consumer's application to a creditor other than the 
loan originator's employer, such as when the employer does not offer 
any loan products for which the consumer would qualify. If the loan 
originator is compensated for arranging the loan with the other 
creditor, the originator is not an employee of the creditor in that 
transaction and is subject to Sec.  226.36(e)(1). See comment 36(e)(1)-
2.ii.
Safe Harbor; Loan Options Presented
    As noted above, to facilitate compliance with the anti-steering 
rule, the Board proposed to create a safe harbor in Sec. Sec.  
226.36(e)(2) and (3). Under the proposal, a loan originator would be 
deemed to comply with the anti-steering rule if, under certain 
conditions, the consumer is presented with a choice of loan options 
that include (1) the lowest interest rate, (2) the second lowest 
interest rate, and (3) the lowest total dollar amount for origination 
points or fees and discount points. For the reasons discussed below, 
the Board is adopting the proposed safe harbor, with technical 
clarifications and a modification to the set of loan options that a 
loan originator must present to the consumer to qualify for the safe 
harbor.
    Under the final rule, a loan originator is deemed to have complied 
with the anti-steering rule in Sec.  226.36(e)(1) if it

[[Page 58529]]

satisfies each of three requirements: (1) For each type of transaction 
in which the consumer expressed an interest (i.e., a fixed-rate, 
adjustable-rate, or a reverse mortgage), the consumer is presented with 
and able to choose from loan options that include a loan with the 
lowest interest rate, a loan with the lowest total dollar amount for 
origination points or fees and discount points, and a loan with the 
lowest rate with no risky features, such as a prepayment penalty or 
negative amortization; (2) the loan options presented to the consumer 
are obtained by the loan originator from a significant number of the 
creditors with whom the loan originator regularly does business; and 
(3) the loan originator believes in good faith that the consumer likely 
qualifies for the loan options presented to the consumer. The loan 
originator need only evaluate loan offers that are available from 
creditors with whom the loan originator regularly does business. See 
Sec. Sec.  226.36(e)(2)(i)-(iii), 226.36(e)(3)(i)(A)-(C), and 
226.36(e)(3)(ii) and corresponding commentary.
    The safe harbor is intended to provide loan originators with clear 
guidance to ensure that they can comply with the anti-steering rule in 
Sec.  226.36(e). At the same time, the Board believes the safe harbor 
must be sufficiently flexible to ensure consumers are not unduly 
restricted from considering various loan options. There is no uniform 
method available for determining which loans may be in the consumer's 
interest. Consumers and loan originators generally consider various 
terms and conditions in relation to other external factors, such as how 
long the consumer expects to hold the loan or the creditor's reputation 
for delivering loans within a promised timeframe. Thus, some consumers 
may reasonably determine that the financial risk created by a certain 
loan feature, for example shared equity, is acceptable in light of the 
loan's lower interest rate, while other consumers may prefer to accept 
a higher rate to avoid the risk associated with a shared equity feature 
(e.g., potential loss of future equity). The Board believes that 
consumer advocates' suggestion for narrowing the safe harbor to permit 
only one type of loan option would unduly restrict consumer choice and 
access to credit.
    The Board believes, however, that there is merit in limiting the 
safe harbor to circumstances where the loan originator offers a loan 
option without certain risk features. Such a requirement may serve to 
deter loan originators from steering consumers to loans with riskier 
features than they would otherwise choose simply to earn greater 
compensation. In addition, requiring loan originators to present a loan 
option with the lowest rate and without certain risky features to 
obtain the benefit of the safe harbor should place consumers in a 
better position to compare more traditional loans to loans with riskier 
features and might result in more consumers opting for ``traditional'' 
loans. To this end, such a requirement serves TILA's purpose of 
avoiding the uninformed use of credit. See TILA Section 102(a), 15 
U.S.C. 1601(a).
    For these reasons, the final rule modifies the safe harbor to 
require that, in addition to loan options with the lowest rate and the 
lowest total dollar amount for origination points or fees and discount 
points, one of the loan options presented to a consumer be a loan with 
the lowest interest rate that is without any of the following features: 
Negative amortization; a prepayment penalty; a balloon payment in the 
first 7 years; a demand feature; shared equity; or shared appreciation. 
The final rule also provides that if the consumer expresses an interest 
in a reverse mortgage, a loan without a prepayment penalty, or a 
shared-equity or shared-appreciation feature must be presented. See 
Sec.  226.36(e)(3)(i)(B). This loan option requirement replaces the 
requirement under the proposal to offer the consumer a loan option with 
the second lowest rate. In technical revisions, Sec. Sec.  226.36(e)(2) 
and (e)(3)(i) are further clarified that to obtain the safe harbor, 
loan originators must present loan options to the consumer that include 
the loan options identified in Sec.  226.36(e)(3)(i); no substantive 
change is intended. In addition, comments 36(e)-1 through -4 are 
adopted as proposed to provide guidance on the application of the rule.
    The Board believes that requiring loan originators to present loan 
offers with the lowest interest rate and the lowest total dollar amount 
for origination points or fees and discount points to avail themselves 
of the safe harbor will prevent the most egregious practices of 
originators steering consumers to more expensive loans. Such a 
requirement may also help to ensure that consumers are able to choose 
from low-cost alternatives. The Board is not adopting the 
recommendation by some commenters to provide a rebuttable presumption 
rather than a safe harbor. As noted above, consumers may choose loans 
for a variety of reasons, depending on their individual circumstances 
and preferences. The anti-steering rule is intended to deter the most 
egregious practices of steering consumers to more expensive loans 
simply to earn greater compensation, while at the same time preserving 
consumers' credit options. The Board believes that a presumption of 
compliance would not serve this purpose as well as a safe harbor, 
because creditors could incur greater risk by offering more loan 
options to consumers. See comment 36(e)(2)-1, adopted as proposed, 
clarifying that there is no presumption regarding the loan originator's 
compliance or noncompliance with Sec.  226.36(e)(1) where a loan 
originator does not satisfy Sec.  226.36(e)(2).
    Comment 36(e)(1)-2.i, adopted substantially as proposed, clarifies 
that in determining whether a transaction is in the consumer's 
interest, the loan originator must compare that transaction to other 
possible loan offers available through the originator, and for which 
the loan originator in good faith believes the consumer is likely to 
qualify, at the time that transaction was offered to the consumer. The 
loan originator need only evaluate those loan offers that are available 
from creditors with whom the loan originator regularly does business. 
That is, the final rule does not require a loan originator to establish 
a new business relationship with any creditor.
    The Board is also adopting Sec.  226.36(e)(3)(iii), as proposed, 
which provides that if a loan originator presents more than three loans 
to the consumer for each type of transaction in which the consumer 
expresses an interest, the loan originator must highlight the three 
loans that satisfy the criteria of the safe harbor, as discussed above.
    Some commenters expressed concern, however, that the safe harbor 
would unnecessarily require loan originators to present consumers with 
a minimum of three loan options where one or two loan options satisfied 
the criteria set forth in Sec.  226.36(e)(3)(i). To address these 
commenters' concerns, the final rule includes new Sec.  226.36(e)(4) to 
provide that if a single loan fulfills the criteria of all loan options 
listed in Sec.  226.36(e)(3)(i), loan originators satisfy the 
requirements of the safe harbor by presenting that loan to the 
consumer. Thus, loan originators can present fewer than three loans and 
satisfy Sec. Sec.  226.36(e)(2) and (e)(3)(i) if the loans presented 
meet the criteria of the options set forth in Sec.  226.36(e)(3). 
Furthermore, comment 36(e)(2)-2, which is adopted substantially as 
proposed, provides additional clarification that presenting more than 
four loans for each transaction type in which the consumer expressed an 
interest and for which the consumer likely qualifies would not likely 
help

[[Page 58530]]

consumers make a meaningful choice. As noted above, if a loan 
originator presents more than three loans to a consumer, the loan 
originator must highlight the three loans that satisfy the criteria set 
out in the final rule.
    Alternatives not adopted. A Federal banking agency recommended 
offering a safe harbor if the loan originator completed a trade-off 
table in the RESPA Good Faith Estimate (GFE). The Board is not adopting 
the recommendation to provide a safe harbor for a completed trade-off 
table in the RESPA GFE. The trade-off table is designed to help 
consumers understand the trade-off between interest rates and points. 
While understanding this trade-off is beneficial, it is not sufficient, 
by itself, to protect consumers against steering. For example, the 
trade-off table would not highlight that a loan has a prepayment 
penalty or other risky feature. Moreover, for adjustable-rate products, 
the trade-off table reflects only the initial interest rate and not the 
rate at first adjustment or the maximum possible interest rate. In some 
cases, a trade-off table might lead a consumer to choose an adjustable 
rate mortgage because of a low initial rate, without the consumer 
realizing that the rate could rapidly and significantly increase.

VII. Mandatory Compliance Dates; Effective Dates

    The Board requested comment on the length of time necessary for 
creditors to implement the proposed rule. Industry commenters and their 
trade associations requested an implementation period of at least 18 to 
24 months. The SBA recommended that the Board delay implementation for 
at least 18 months for small entities. Many of these commenters 
explained that the proposed rule involved extensive revisions to 
current business practices regarding loan originator compensation. In 
contrast, consumer advocates asked that the proposed rule become 
effective immediately or at least very quickly in light of the 
substantial consumer injury resulting from loan originator 
compensation.
    Under TILA Section 105(d), certain of the Board's disclosure 
regulations are to have an effective date of that October 1 which 
follows by at least six months the date of promulgation. 15 U.S.C. 
1604(d). However, the Board may at its discretion lengthen the 
implementation period for creditors to adjust their forms to 
accommodate new requirements, or shorten the period where the Board 
finds that such action is necessary to prevent unfair or deceptive 
disclosure practices. No similar effective date requirement exists for 
non-disclosure regulations. The Riegle Community Development and 
Regulatory Improvement Act of 1994, however, requires that agency 
regulations which impose additional reporting, disclosure and other 
requirements on insured depository institutions take effect on the 
first day of a calendar quarter following publication in final form. 12 
U.S.C. 4802(b).
    Compliance with the final rule will be mandatory on April 1, 2011. 
See comment 36-2. Thus, the final rule applies to loan originator 
compensation for transactions subject to Sec.  226.36(d) and (e), for 
which creditors receive applications on or after April 1, 2011. The 
Board believes that this will provide sufficient time for creditors and 
loan originators to make the necessary adjustments to their 
compensation agreements and practices to conform to the final rule. A 
longer compliance time such as the 18 to 24 months suggested by 
creditors is not necessary, given that the rule does not require 
changes to the timing, content and format of mortgage disclosure forms.
    Compliance with the provisions of the final rule is not required 
before the effective date. Thus, the final rule and the Board's 
accompanying analysis should have no bearing on whether the acts and 
practices that are restricted or prohibited under this final rule are 
deemed to be unfair or deceptive if they occur before the effective 
date of this rule. Unfair acts or practices can be addressed through 
case-by-case enforcement actions against specific institutions or 
individuals, through regulations applying to all institutions and 
individuals, or both. An enforcement action concerns a specific 
institution's or individual's conduct and is based on all of the facts 
and circumstances surrounding that conduct. By contrast, a regulation 
is prospective and applies to the market as a whole, drawing bright 
lines that distinguish broad categories of conduct.
    Because broad regulations, such as those in the final rule, can 
require large numbers of institutions and individuals to make major 
adjustments to their practices, there could be more harm to consumers 
than benefit if the regulations were effective earlier than the 
effective date. If institutions and individuals were not provided a 
reasonable time to make changes to their operations and systems to 
comply with the final rule, they would either incur excessively large 
expenses, which would be passed on to consumers, or cease engaging in 
the regulated activity altogether, to the detriment of consumers. And 
because an act or practice is unfair only when the harm outweighs the 
benefits to consumers or to competition, the implementation period 
preceding the effective date set forth in the final rule is integral to 
the Board's decision to restrict or prohibit certain acts or practices 
by regulation.
    For these reasons, acts or practices occurring before the effective 
date of this final rule will be judged on the totality of the 
circumstances under applicable laws or regulations. Similarly, acts or 
practices occurring after this final rule's effective date that are not 
governed by these rules will continue to be judged on the totality of 
the circumstances under applicable laws or regulations.

VIII. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995, 44 U.S.C. 
3506; 5 CFR 1320 Appendix A.1, the Board has reviewed the final rule 
under authority delegated to the Board by the Office of Management and 
Budget. The final rule contains no new collections of information and 
proposes no substantive changes to existing collections of information 
pursuant to the Paperwork Reduction Act.
    As discussed above, on August 26, 2009 the Board published in the 
Federal Register a notice of proposed rulemaking to amend Regulation Z. 
74 FR 43232. The comment period for this notice expired on December 24, 
2009. The Board is continuing to review all of the comments and is in 
the process of developing several final rules.
    The Board has a continuing interest in the public's opinions of its 
collections of information. At any time, comments regarding the burden 
estimate or any other information, including suggestions for reducing 
the burden may be sent to: Secretary, Board of Governors of the Federal 
Reserve System, 20th and C Streets, NW., Washington, DC 20551; and to 
the Office of Management and Budget, Paperwork Reduction Project (7100-
0199), Washington, DC 20503.

IX. Final Regulatory Flexibility Analysis

    In accordance with section 4(a) of the Regulatory Flexibility Act 
(RFA), 5 U.S.C. Sec. Sec.  601-612, the Board is publishing a final 
regulatory flexibility analysis for the amendments to Regulation Z. The 
RFA requires an agency either to provide a final regulatory flexibility 
analysis with a final rule or to certify that the final rule will not 
have a significant economic impact on a substantial number of small 
entities. Under regulations issued by the SBA, an entity is considered 
``small'' if it has $175 million or less in assets for banks and other 
depository institutions;

[[Page 58531]]

and $7 million or less in revenues for non-bank mortgage lenders and 
mortgage brokers.\32\
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    \32\ 13 CFR 121.201.
---------------------------------------------------------------------------

    The Board received a large number of comments contending that the 
proposed rule would have a significant impact on various businesses. 
Based on public comment, the Board's own analysis, and for the reasons 
stated below, the Board believes that this final rule will have a 
significant economic impact on a substantial number of small entities.

A. Statement of Need for, and Objectives of, the Final Rule

    Congress enacted TILA 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. One of the stated purposes of TILA is 
to provide a meaningful disclosure of credit terms to enable consumers 
to compare credit terms available in the marketplace more readily and 
avoid the uninformed use of credit. TILA also contains procedural and 
substantive protections for consumers. TILA directs the Board to 
prescribe regulations to carry out the purposes of the statute. The 
Board's Regulation Z implements TILA.
    Congress enacted HOEPA in 1994 as an amendment to TILA. HOEPA 
imposed additional substantive protections on certain high-cost 
mortgage transactions. HOEPA also charged the Board with prohibiting 
acts or practices in connection with mortgage loans that are unfair, 
deceptive, or designed to evade the purposes of HOEPA, and acts or 
practices in connection with refinancing of mortgage loans that are 
associated with abusive lending practices or are otherwise not in the 
interest of borrowers.
    The final rule restricts certain loan originator compensation 
practices to address problems that have been observed in the mortgage 
market. These restrictions are proposed pursuant to the Board's 
statutory responsibility to prohibit unfair and deceptive acts and 
practices in connection with mortgage loans.

B. Summary of Issues Raised by Comments in Response to the Initial 
Regulatory Flexibility Analysis

    In accordance with section 3(a) of the RFA, 5 U.S.C 603(a), the 
Board prepared an initial regulatory flexibility analysis (IRFA) in 
connection with the proposed rule, and acknowledged that the projected 
reporting, recordkeeping, and other compliance requirements of the 
proposed rule would have a significant economic impact on a substantial 
number of small entities. In addition, the Board recognized that the 
precise compliance costs would be difficult to ascertain because they 
would depend on a number of unknown factors, including, among other 
things, the specifications of the current systems used by small 
entities to administer and maintain accounts, the complexity of the 
terms of credit products that they offer, and the range of such product 
offerings. The Board sought information and comment on any costs, 
compliance requirements, or changes in operating procedures arising 
from the application of the proposed rule to small entities.
    The Board reviewed comments submitted by various entities in order 
to ascertain the economic impact of the proposed rule on small 
entities. A number of financial institutions and mortgage brokers 
expressed concern that the Board had underestimated the costs of 
compliance. In addition, the SBA submitted a comment on the Board's 
IRFA. Executive Order 13272 directs Federal agencies to respond in a 
final rule to written comments submitted by the SBA on a proposed rule, 
unless the agency certifies that the public interest is not served by 
doing so. The Board's response to the SBA's comment letter is 
below.\33\
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    \33\ Advocacy commented on all of the provisions in the Board's 
August 2009 Closed-End Proposal. The Board is responding in this 
final rule only to Advocacy's comments that relate to this final 
rule regarding loan originator compensation. The Board will respond 
to Advocacy's comments on other proposed provisions when any final 
rules on those provisions are issued.
---------------------------------------------------------------------------

    Response to the SBA. The SBA expressed concern that the Board's 
IRFA did not adequately assess the impact of the proposed rule on small 
entities as required by the RFA. The SBA urged the Board to issue a new 
proposal containing a revised IRFA. For the reasons stated below, the 
Board believes that its IRFA complied with the requirements of the RFA 
and the Board is proceeding with a final rule.
    The SBA suggested that the Board failed to provide sufficient 
information about the economic impact of the proposed rule and that the 
Board's request for public comment on the costs to small entities of 
the proposed rule was not appropriate. Section 3(a) of the RFA requires 
agencies to publish for comment an IRFA which shall describe the impact 
of the proposed rule on small entities. 5 U.S.C. 603(a). In addition, 
section 3(b) requires the IRFA to contain certain information including 
a description of the projected reporting, recordkeeping and other 
compliance requirements of the proposed rule, including an estimate of 
the classes of small entities which will be subject to the requirement 
and the type of professional skills necessary for preparation of the 
report or record. 5 U.S.C. 603(b).
    The Board's IRFA complied with the requirements of the RFA. The 
IRFA procedure is ``intended to evoke commentary from small businesses 
about the effect of the rule on their activities, and to require 
agencies to consider the effect of a regulation on those entities.'' 
Cement Kiln Recycling Coalition v. EPA, 255 F.3d 855, 868 (D.C. Cir. 
2001). The RFA does not require that the Board be able to project the 
specific dollar amount that a rule will cost small entities in order to 
implement the rule; rather it requires a description of the projected 
impact of the rule on small entities and of reporting, recordkeeping, 
or compliance requirements. 5 U.S.C. 603(a), 603(b)(4). Accordingly, 
the Board described the projected impact of the proposed rule and 
sought comments from small entities themselves on the effect the 
proposed rule would have on their activities. First, the Board 
described the impact of the proposed rule on small entities by 
describing the rule's proposed requirements in detail throughout the 
supplementary information for the proposed rule. Second, the Board 
described the projected compliance requirements of the rule in its 
IRFA, noting the need for small entities to comply with recordkeeping 
requirements, and update systems and loan origination practices.\34\
---------------------------------------------------------------------------

    \34\ 74 FR 43232, 43320; Aug. 26, 2009.
---------------------------------------------------------------------------

    The SBA also commented that the Board failed to provide sufficient 
information about the number of small mortgage brokers that may be 
impacted by the rule. Section 3(b)(3) of the RFA requires the IRFA to 
contain a description of and, where feasible, an estimate of the number 
of small entities to which the proposed rule will apply. 5 U.S.C. 
603(b)(3) (emphasis added). The Board provided a description of the 
small entities to which the proposed rule would apply and provided an 
estimate of the number of small depository institutions to which the 
proposed rule would apply.\35\ The Board also provided an estimate of 
the total number of mortgage broker entities and estimated that most of 
these were

[[Page 58532]]

small entities.\36\ The Board stated that it was not aware of a 
reliable source for the total number of small entities likely to be 
affected by the proposal.\37\ Thus, the Board did not find it feasible 
to estimate their number. The Board has previously requested 
information on the number of small entities, including small mortgage 
broker entities, in its 2008 proposed rule under HOEPA.\38\ Comment 
letters received by the Board on both the current and the 2008 
proposals, including the SBA's comment letters, have not provided 
additional sources of information about the number of small entities 
affected.
---------------------------------------------------------------------------

    \35\ Id. at 43319-43320.
    \36\ Id.
    \37\ Id. at 43319.
    \38\ 73 FR 1672, 1720; Jan. 9, 2008.
---------------------------------------------------------------------------

    The SBA also suggested that the Board's IRFA did not sufficiently 
address alternatives to the proposed rule, especially as they relate to 
small entities. Section 3(c) of the RFA requires that an IRFA contain a 
description of any significant alternatives to the proposed rule which 
accomplish the stated objectives of applicable statutes and which 
minimize any significant economic impact of the proposed rule on small 
entities. 5 U.S.C. 603(c) (emphasis added). However, the Board's IRFA 
discusses the alternative of improved disclosures and requests comment 
on other alternatives.\39\
---------------------------------------------------------------------------

    \39\ Section 5(a) of the RFA permits an agency to perform the 
IRFA analysis (among others) in conjunction with or as part of any 
other analysis required by any other law if such other analysis 
satisfies the provisions of the RFA. 5 U.S.C. 605(a). Other 
alternatives were discussed throughout the supplementary information 
to the Board's proposal.
---------------------------------------------------------------------------

    The SBA's comment letter recommended that the Board replace the 
proposed substantive rule restricting originator practices with a 
requirement that creditors disclose the lowest interest rate they would 
accept for a given loan. However, the Board's IRFA discussion of the 
disclosure alternative indicates why the Board does not believe that 
such a disclosure alternative would accomplish the stated objectives of 
applicable statutes.\40\ The Board has extensively considered whether 
additional disclosures, including disclosing the loan originator's 
compensation, would achieve the statutory objectives of HOEPA, and even 
proposed such a disclosure requirement in the 2008 HOEPA Proposed 
Rule.\41\ However, public comment on that proposal, and consumer 
testing conducted for the Board, provided strong evidence that 
additional disclosures would not accomplish the goal of HOEPA and the 
Board's proposal to prevent unfair or deceptive origination practices, 
which led the Board to withdraw the proposal.\42\ The SBA's comment 
letter asserts that the disclosure alternative should be sufficient to 
accomplish the Board's regulatory goals, yet it fails to mention the 
public comment or consumer testing findings relating to the Board's 
withdrawn 2008 proposal.
---------------------------------------------------------------------------

    \40\ 74 FR 43232, 43320; Aug. 26, 2009.
    \41\ 73 FR 1672; Jan. 9, 2008.
    \42\ 73 FR 44522; July 30, 2008.
---------------------------------------------------------------------------

    The SBA also suggested that, according to a mortgage broker 
industry trade group, the proposed definition of ``loan originator'' 
would limit the flexibility and loan pricing and product options that 
small business entities can offer. The SBA urged the Board to give full 
consideration to the trade group's comments. As discussed in the 
SUPPLEMENTARY INFORMATION above, the Board has carefully considered 
these comments. The final rule is intended to uniformly address the 
harm that can result from unfair compensation practices, and the Board 
believes that providing exemptions for any set of loan originators 
would facilitate circumvention of the rule and undermine its objective. 
Furthermore, as discussed in the SUPPLEMENTARY INFORMATION above, the 
final rule still affords 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.
    As the SBA notes, the Board requested comment in the supplementary 
information to the proposal on an alternative that would permit 
compensation based on loan amount. The Board is adopting this 
alternative in the final rule.
    Other comments. In addition to the SBA's comment letter, a number 
of industry commenters expressed concerns that the rule, as proposed, 
would be costly to implement, would not provide enough flexibility, and 
would not adequately respond to the needs or nature of their business. 
Mortgage brokers argued that the Board should consider alternatives 
that would exempt small entities from the proposed rule or mitigate the 
application of the proposed rule on small entities. As discussed above, 
the Board concluded that these suggestions do not represent significant 
alternatives to the proposed rule because they would not meet the 
objectives of the rule. Many of the issues raised by commenters do not 
apply uniquely to small entities and are addressed above in other parts 
of the SUPPLEMENTARY INFORMATION.

C. Description of Small Entities to Which the Final Rule Will Apply

    The final rule will apply to all institutions and entities that 
engage in originating or extending closed-end, home-secured credit. The 
Board is not aware of a reliable source for the total number of small 
entities likely to be affected by the final rule, and the credit 
provisions of TILA and Regulation Z have broad applicability to 
individuals and businesses that originate, extend and service even 
small numbers of home-secured credit. See Sec.  226.1(c)(1).\43\ All 
small entities that originate or extend closed-end loans secured by 
real property or a dwelling potentially could be subject to at least 
some aspects of the final rule.
---------------------------------------------------------------------------

    \43\ Regulation Z generally applies to ``each individual or 
business that offers or extends credit when four conditions are met: 
(i) The credit is offered or extended to consumers; (ii) the 
offering or extension of credit is done regularly; (iii) the credit 
is subject to a finance charge or is payable by a written agreement 
in more than four installments, and (iv) the credit is primarily for 
personal, family, or household purposes.'' Sec.  226.1(c)(1).
---------------------------------------------------------------------------

    The Board can, however, identify through data from Reports of 
Condition and Income (call reports) approximate numbers of small 
depository institutions that will be subject to the final rule. 
According to March 2010 Call Report data, approximately 8,848 small 
depository institutions will be subject to the rule. Approximately 
15,899 depository institutions in the United States filed Call Report 
data, approximately 11,218 of which had total domestic assets of $175 
million or less and thus were considered small entities for purposes of 
the RFA. Of the 3,898 banks, 523 thrifts, 6,727 credit unions, and 70 
branches of foreign banks that filed Call Report data and were 
considered small entities, 3,776 banks, 496 thrifts, 4,573 credit 
unions, and 3 branches of foreign banks, totaling 8,848 institutions, 
extended mortgage credit. For purposes of this Call Report analysis, 
thrifts include savings banks, savings and loan entities, co-operative 
banks and industrial banks.
    The Board cannot identify with certainty the number of small non-
depository institutions that will be subject to the final rule. Home 
Mortgage Disclosure Act (HMDA) data indicate that 1,507 non-depository 
institutions (independent mortgage companies, subsidiaries of a 
depository institution, or affiliates of a bank holding company) filed 
HMDA reports in 2009 for 2008 lending activities. Based on the small 
volume of lending activity reported by these institutions, most are 
likely to be small.

[[Page 58533]]

    The final rule will apply to mortgage brokers. Loan originators 
other than mortgage brokers that will be affected by the final rule are 
employees of creditors (or of brokers) and, as such, are not business 
entities in their own right. In its 2008 proposed rule under HOEPA, 73 
FR 1672, 1720; Jan. 9, 2008, the Board noted that, according to the 
National Association of Mortgage Brokers (NAMB), there were 53,000 
mortgage brokerage companies in 2004 that employed an estimated 418,700 
people.\44\ The Board estimated that most of these companies are small 
entities. On the other hand, the U.S. Census Bureau's 2002 Economic 
Census indicates that there were only 17,041 ``mortgage and nonmortgage 
loan brokers'' in the United States at that time.\45\
---------------------------------------------------------------------------

    \44\ http://www.namb.org/namb/Industry_Facts.asp?SnID=719224934. This page of the NAMB Web site, however, 
no longer provides an estimate of the number of mortgage brokerage 
companies.
    \45\ http://www.census.gov/prod/ec02/ec0252a1us.pdf (NAICS code 
522310).
---------------------------------------------------------------------------

D. Reporting, Recordkeeping, and Other Compliance Requirements

    The compliance requirements of the final rule are described in the 
SUPPLEMENTARY INFORMATION. Some small entities will be required, among 
other things, to alter certain business practices, develop new business 
models, re-train staff, and reprogram operational systems to ensure 
compliance with the final rule. In addition, Regulation Z currently 
requires creditors to retain evidence of compliance with Regulation Z 
for two years. As described in the SUPPLEMENTARY INFORMATION, the final 
rule clarifies the types of records that creditors must retain to 
demonstrate compliance with the rule. The effect of the final rule on 
small entities is unknown. The final rule could affect how loan 
originators are compensated and will impose certain related 
recordkeeping requirements on creditors. The precise costs that the 
final rule will impose on mortgage creditors and loan originators are 
difficult to ascertain. As discussed above, the Board has requested 
information about the impact of the rule on small entities but has not 
received additional sources of information about the number of small 
entities affected or the costs to small entities. Nevertheless, the 
Board believes that these costs will have a significant economic effect 
on small entities, including small mortgage creditors and brokers.

E. Steps Taken To Minimize the Economic Impact on Small Entities

    The steps the Board has taken to minimize the economic impact and 
compliance burden on small entities, including the factual, policy, and 
legal reasons for selecting the alternatives adopted and why each one 
of the other significant alternatives was not accepted, are described 
above in the SUPPLEMENTARY INFORMATION and in the summary of issues 
raised by the public comments in response to the proposal's IRFA. For 
example, the Board has adopted an alternative that permits loan 
originator compensation to be based on loan amount. The SBA and small 
entity commenters stated that this alternative would be less burdensome 
and would provide more flexibility to small entity loan originators. In 
addition, the final rule does not apply to open-end credit or timeshare 
plans, and the final rule does not extend the record retention 
requirement to persons other than the creditor who pays loan originator 
compensation. The Board believes that these provisions minimize the 
significant economic impact on small entities while still meeting the 
stated objectives of HOEPA and TILA.

List of Subjects in 12 CFR Part 226

    Advertising, Consumer protection, Federal Reserve System, 
Mortgages, Reporting and recordkeeping requirements, Truth in lending.

Authority and Issuance

0
For the reasons set forth in the preamble, the Board amends Regulation 
Z, 12 CFR part 226, as set forth below:

PART 226--TRUTH IN LENDING (REGULATION Z)

0
1. The authority citation for part 226 continues to read as follows:

    Authority:  12 U.S.C. 3806; 15 U.S.C. 1604, 1637(c)(5), and 
1639(l); Pub L. 111-24 Sec.  2, 123 Stat. 1734.

Subpart A--General

0
2. Section 226.1 is amended by revising paragraphs (b) and (d)(5) to 
read as follows:


Sec.  226.1  Authority, purpose, coverage, organization, enforcement, 
and liability.

* * * * *
    (b) Purpose. The purpose of this regulation is to promote the 
informed use of consumer credit by requiring disclosures about its 
terms and cost. The regulation also includes substantive protections. 
It gives consumers the right to cancel certain credit transactions that 
involve a lien on a consumer's principal dwelling, regulates certain 
credit card practices, and provides a means for fair and timely 
resolution of credit billing disputes. The regulation does not 
generally govern charges for consumer credit, except that several 
provisions in Subpart G set forth special rules addressing certain 
charges applicable to credit card accounts under an open-end (not home-
secured) consumer credit plan. The regulation requires a maximum 
interest rate to be stated in variable-rate contracts secured by the 
consumer's dwelling. It also imposes limitations on home-equity plans 
that are subject to the requirements of Sec.  226.5b and mortgages that 
are subject to the requirements of Sec.  226.32. The regulation 
prohibits certain acts or practices in connection with credit secured 
by a dwelling in Sec.  226.36, and credit secured by a consumer's 
principal dwelling in Sec.  226.35. The regulation also regulates 
certain practices of creditors who extend private education loans as 
defined in Sec.  226.46(b)(5).
* * * * *
    (d) * * *
    (5) Subpart E contains special rules for mortgage transactions. 
Section 226.32 requires certain disclosures and provides limitations 
for closed-end loans that have rates or fees above specified amounts. 
Section 226.33 requires special disclosures, including the total annual 
loan cost rate, for reverse mortgage transactions. Section 226.34 
prohibits specific acts and practices in connection with closed-end 
mortgage transactions that are subject to Sec.  226.32. Section 226.35 
prohibits specific acts and practices in connection with closed-end 
higher-priced mortgage loans, as defined in Sec.  226.35(a). Section 
226.36 prohibits specific acts and practices in connection with an 
extension of credit secured by a dwelling.
* * * * *

Subpart E--Special Rules for Certain Home Mortgage Transactions

0
3. Section 226.36 is amended by:
0
A. Revising the section heading;
0
B. Revising paragraph (a);
0
C. Redesignating paragraph (d) as paragraph (f) and revising it; and
0
D. Adding new paragraphs (d) and (e).
    The additions and revisions read as follows:


Sec.  226.36  Prohibited acts or practices in connection with credit 
secured by a dwelling.

    (a) Loan originator and mortgage broker defined. (1) Loan 
originator. For purposes of this section, the term ``loan originator'' 
means with respect to a

[[Page 58534]]

particular transaction, a person who for compensation or other monetary 
gain, or in expectation of compensation or other monetary gain, 
arranges, negotiates, or otherwise obtains an extension of consumer 
credit for another person. The term ``loan originator'' includes an 
employee of the creditor if the employee meets this definition. The 
term ``loan originator'' includes the creditor only if the creditor 
does not provide the funds for the transaction at consummation out of 
the creditor's own resources, including drawing on a bona fide 
warehouse line of credit, or out of deposits held by the creditor.
    (2) Mortgage broker. For purposes of this section, a mortgage 
broker with respect to a particular transaction is any loan originator 
that is not an employee of the creditor.
* * * * *
    (d) Prohibited payments to loan originators. (1) Payments based on 
transaction terms or conditions. (i) In connection with a consumer 
credit transaction secured by a dwelling, no loan originator shall 
receive and no person shall pay to a loan originator, directly or 
indirectly, compensation in an amount that is based on any of the 
transaction's terms or conditions.
    (ii) For purposes of this paragraph (d)(1), the amount of credit 
extended is not deemed to be a transaction term or condition, provided 
compensation received by or paid to a loan originator, directly or 
indirectly, is based on a fixed percentage of the amount of credit 
extended; however, such compensation may be subject to a minimum or 
maximum dollar amount.
    (iii) This paragraph (d)(1) shall not apply to any transaction in 
which paragraph (d)(2) of this section applies.
    (2) Payments by persons other than consumer. If any loan originator 
receives compensation directly from a consumer in a consumer credit 
transaction secured by a dwelling:
    (i) No loan originator shall receive compensation, directly or 
indirectly, from any person other than the consumer in connection with 
the transaction; and
    (ii) No person who knows or has reason to know of the consumer-paid 
compensation to the loan originator (other than the consumer) shall pay 
any compensation to a loan originator, directly or indirectly, in 
connection with the transaction.
    (3) Affiliates. For purposes of this paragraph (d), affiliates 
shall be treated as a single ``person.''
    (e) Prohibition on steering. (1) General. In connection with a 
consumer credit transaction secured by a dwelling, a loan originator 
shall not direct or ``steer'' a consumer to consummate a transaction 
based on the fact that the originator will receive greater compensation 
from the creditor in that transaction than in other transactions the 
originator offered or could have offered to the consumer, unless the 
consummated transaction is in the consumer's interest.
    (2) Permissible transactions. A transaction does not violate 
paragraph (e)(1) of this section if the consumer is presented with loan 
options that meet the conditions in paragraph (e)(3) of this section 
for each type of transaction in which the consumer expressed an 
interest. For purposes of paragraph (e) of this section, the term 
``type of transaction'' refers to whether:
    (i) A loan has an annual percentage rate that cannot increase after 
consummation;
    (ii) A loan has an annual percentage rate that may increase after 
consummation; or
    (iii) A loan is a reverse mortgage.
    (3) Loan options presented. A transaction satisfies paragraph 
(e)(2) of this section only if the loan originator presents the loan 
options required by that paragraph and all of the following conditions 
are met:
    (i) The loan originator must obtain loan options from a significant 
number of the creditors with which the originator regularly does 
business and, for each type of transaction in which the consumer 
expressed an interest, must present the consumer with loan options that 
include:
    (A) The loan with the lowest interest rate;
    (B) The loan with the lowest interest rate without negative 
amortization, a prepayment penalty, interest-only payments, a balloon 
payment in the first 7 years of the life of the loan, a demand feature, 
shared equity, or shared appreciation; or, in the case of a reverse 
mortgage, a loan without a prepayment penalty, or shared equity or 
shared appreciation; and
    (C) The loan with the lowest total dollar amount for origination 
points or fees and discount points.
    (ii) The loan originator must have a good faith belief that the 
options presented to the consumer pursuant to paragraph (e)(3)(i) of 
this section are loans for which the consumer likely qualifies.
    (iii) For each type of transaction, if the originator presents to 
the consumer more than three loans, the originator must highlight the 
loans that satisfy the criteria specified in paragraph (e)(3)(i) of 
this section.
    (4) Number of loan options presented. The loan originator can 
present fewer than three loans and satisfy paragraphs (e)(2) and 
(e)(3)(i) of this section if the loan(s) presented to the consumer 
satisfy the criteria of the options in paragraph (e)(3)(i) of this 
section and the provisions of paragraph (e)(3) of this section are 
otherwise met.
    (f) This section does not apply to a home-equity line of credit 
subject to Sec.  226.5b. Section 226.36(d) and (e) do not apply to a 
loan that is secured by a consumer's interest in a timeshare plan 
described in 11 U.S.C. 101(53D).

0
4. In Supplement I to Part 226:
0
A. Under Section 226.25--Record Retention, 25(a) General rule, new 
paragraph 5 is added.
0
B. Under Section 226.36--Prohibited Acts or Practices in Connection 
With Credit Secured by a Dwelling ,
0
1. Revise the heading;
0
2. Redesignate paragraph 1 as paragraph 3;
0
3. Add paragraphs 1 and 2;
0
4. Under 36(a) Mortgage broker defined, revise the heading, revise 
paragraph 1, and add paragraphs 2, 3, and 4; and
0
5. Add entries for 36(d) Prohibited payments to loan originators and 
36(e) Prohibition on steering.
    The additions and revisions read as follows:

Supplement I To Part 226--Official Staff Interpretations

* * * * *

Subpart D--Miscellaneous

* * * * *

Section 226.25--Record Retention

    25(a) General rule.
* * * * *
    5. Prohibited payments to loan originators. For each transaction 
subject to the loan originator compensation provisions in Sec.  
226.36(d)(1), a creditor should maintain records of the compensation 
it provided to the loan originator for the transaction as well as 
the compensation agreement in effect on the date the interest rate 
was set for the transaction. See Sec.  226.35(a) and comment 
35(a)(2)(iii)-3 for additional guidance on when a transaction's rate 
is set. For example, where a loan originator is a mortgage broker, a 
disclosure of compensation or other broker agreement required by 
applicable state law that complies with Sec.  226.25 would be 
presumed to be a record of the amount actually paid to the loan 
originator in connection with the transaction.
* * * * *

Subpart E--Special Rules for Certain Home Mortgage Transactions

[[Page 58535]]

* * * * *

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

    1. Scope of coverage. Sections 226.36(b) and (c) apply to 
closed-end consumer credit transactions secured by a consumer's 
principal dwelling. Sections 226.36(d) and (e) apply to closed-end 
consumer credit transactions secured by a dwelling. Sections 
226.36(d) and (e) apply to closed-end loans secured by first or 
subordinate liens, and reverse mortgages that are not home-equity 
lines of credit under Sec.  226.5b. See Sec.  226.36(f) for 
additional restrictions on the scope of this section, and Sec. Sec.  
226.1(c) and 226.3(a) and corresponding commentary for further 
discussion of extensions of credit subject to Regulation Z.
    2. Mandatory compliance date for Sec. Sec.  226.36(d) and (e). 
The final rules on loan originator compensation in Sec.  226.36 
apply to transactions for which the creditor receives an application 
on or after April 1, 2011. For example, assume a mortgage broker 
takes an application on March 10, 2011, which the creditor receives 
on March 25, 2011. This transaction is not covered. If, however, the 
creditor does not receive the application until April 5, 2011, the 
transaction is covered.
* * * * *
    36(a) Loan originator and mortgage broker defined.
    1. Meaning of loan originator. i. General. Section 226.36(a) 
provides that a loan originator is any person who for compensation 
or other monetary gain arranges, negotiates, or otherwise obtains an 
extension of consumer credit for another person. Thus, the term 
``loan originator'' includes employees of a creditor as well as 
employees of a mortgage broker that satisfy this definition. In 
addition, the definition of loan originator expressly includes any 
creditor that satisfies the definition of loan originator but makes 
use of ``table funding'' by a third party. See comment 36(a)-1.ii 
below discussing table funding. Although consumers may sometimes 
arrange, negotiate, or otherwise obtain extensions of consumer 
credit on their own behalf, in such cases they do not do so for 
another person or for compensation or other monetary gain, and 
therefore are not loan originators under this section. (Under Sec.  
226.2(a)(22), the term ``person'' means a natural person or an 
organization.)
    ii. Table funding. Table funding occurs when the creditor does 
not provide the funds for the transaction at consummation out of the 
creditor's own resources, including drawing on a bona fide warehouse 
line of credit, or out of deposits held by the creditor. 
Accordingly, a table-funded transaction is consummated with the debt 
obligation initially payable by its terms to one person, but another 
person provides the funds for the transaction at consummation and 
receives an immediate assignment of the note, loan contract, or 
other evidence of the debt obligation. Although Sec.  
226.2(a)(17)(i)(B) provides that a person to whom a debt obligation 
is initially payable on its face generally is a creditor, Sec.  
226.36(a)(1) provides that, solely for the purposes of Sec.  226.36, 
such a person is also considered a loan originator. The creditor is 
not considered a loan originator unless table funding occurs. For 
example, if a person closes a loan in its own name but does not fund 
the loan from its own resources or deposits held by it because it 
assigns the loan at consummation, it is considered a creditor for 
purposes of Regulation Z and also a loan originator for purposes of 
Sec.  226.36. However, if a person closes a loan in its own name and 
draws on a bona fide warehouse line of credit to make the loan at 
consummation, it is considered a creditor, not a loan originator, 
for purposes of Regulation Z, including Sec.  226.36.
    iii. Servicing. The definition of ``loan originator'' does not 
apply to a loan servicer when the servicer modifies an existing loan 
on behalf of the current owner of the loan. The rule only applies to 
extensions of consumer credit and does not apply if a modification 
of an existing obligation's terms does not constitute a refinancing 
under Sec.  226.20(a).
    2. Meaning of mortgage broker. For purposes of Sec.  226.36, 
with respect to a particular transaction, the term ``mortgage 
broker'' refers to a loan originator who is not an employee of the 
creditor. Accordingly, the term ``mortgage broker'' includes 
companies that engage in the activities described in Sec.  226.36(a) 
and also includes employees of such companies that engage in these 
activities. Section 226.36(d) prohibits certain payments to a loan 
originator. These prohibitions apply to payments made to all loan 
originators, including payments made to mortgage brokers, and 
payments made by a company acting as a mortgage broker to its 
employees who are loan originators.
    3. Meaning of creditor. For purposes of Sec.  226.36(d) and (e), 
a creditor means a creditor that is not deemed to be a loan 
originator on the transaction under this section. Thus, a person 
that closes a loan in its own name (but another person provides the 
funds for the transaction at consummation and receives an immediate 
assignment of the note, loan contract, or other evidence of the debt 
obligation) is deemed a loan originator, not a creditor, for 
purposes of Sec.  226.36. However, that person is still a creditor 
for all other purposes of Regulation Z.
    4. Managers and administrative staff. For purposes of Sec.  
226.36, managers, administrative staff, and similar individuals who 
are employed by a creditor or loan originator but do not arrange, 
negotiate, or otherwise obtain an extension of credit for a 
consumer, and whose compensation is not based on whether any 
particular loan is originated, are not loan originators.
* * * * *
    36(d) Prohibited payments to loan originators.
    1. Persons covered. Section 226.36(d) prohibits any person 
(including the creditor) from paying compensation to a loan 
originator in connection with a covered credit transaction, if the 
amount of the payment is based on any of the transaction's terms or 
conditions. For example, a person that purchases a loan from the 
creditor may not compensate the loan originator in a manner that 
violates Sec.  226.36(d).
    2. Mortgage brokers. The payments made by a company acting as a 
mortgage broker to its employees who are loan originators are 
subject to the section's prohibitions. For example, a mortgage 
broker may not pay its employee more for a transaction with a 7 
percent interest rate than for a transaction with a 6 percent 
interest rate.
    36(d)(1) Payments based on transaction terms and conditions.
    1. Compensation. i. General. For purposes of Sec.  226.36(d) and 
(e), the term ``compensation'' includes salaries, commissions, and 
any financial or similar incentive provided to a loan originator 
that is based on any of the terms or conditions of the loan 
originator's transactions. See comment 36(d)(1)-3 for examples of 
types of compensation that are not covered by Sec.  226.36(d) and 
(e). For example, the term ``compensation'' includes:
    A. An annual or other periodic bonus; or
    B. Awards of merchandise, services, trips, or similar prizes.
    ii. Name of fee. Compensation includes amounts the loan 
originator retains and is not dependent on the label or name of any 
fee imposed in connection with the transaction. For example, if a 
loan originator imposes a ``processing fee'' in connection with the 
transaction and retains such fee, it is deemed compensation for 
purposes of Sec.  226.36(d) and (e), whether the originator expends 
the time to process the consumer's application or uses the fee for 
other expenses, such as overhead.
    iii. Amounts for third-party charges. Compensation includes 
amounts the loan originator retains, but does not include amounts 
the originator receives as payment for bona fide and reasonable 
third-party charges, such as title insurance or appraisals. In some 
cases, amounts received for payment for third-party charges may 
exceed the actual charge because, for example, the originator cannot 
determine with accuracy what the actual charge will be before 
consummation. In such a case, the difference retained by the 
originator is not deemed compensation if the third-party charge 
imposed on the consumer was bona fide and reasonable, and also 
complies with state and other applicable law. On the other hand, if 
the originator marks up a third-party charge (a practice known as 
``upcharging''), and the originator retains the difference between 
the actual charge and the marked-up charge, the amount retained is 
compensation for purposes of Sec.  226.36(d) and (e). For example:
    A. Assume a loan originator charges the consumer a $400 
application fee that includes $50 for a credit report and $350 for 
an appraisal. Assume that $50 is the amount the creditor pays for 
the credit report. At the time the loan originator imposes the 
application fee on the consumer, the loan originator is uncertain of 
the cost of the appraisal because the originator may choose from 
appraisers that charge between $300 to $350 for appraisals. Later, 
the cost for the appraisal is determined to be $300 for this 
consumer's transaction. In this case, the $50 difference between the 
$400 application fee imposed on the consumer and the actual $350 
cost for the credit report and appraisal is not deemed compensation 
for purposes of Sec.  226.36(d) and (e), even though the $50 is 
retained by the loan originator.

[[Page 58536]]

    B. Using the same example in comment 36(d)(1)-1.iii.A above, the 
$50 difference would be compensation for purposes of Sec.  226.36(d) 
and (e) if the appraisers from whom the originator chooses charge 
fees between $250 and $300.
    2. Examples of compensation that is based on transaction terms 
or conditions. Section 226.36(d)(1) prohibits loan originator 
compensation that is based on the terms or conditions of the loan 
originator's transactions. For example, the rule prohibits 
compensation to a loan originator for a transaction based on that 
transaction's interest rate, annual percentage rate, loan-to-value 
ratio, or the existence of a prepayment penalty. The rule also 
prohibits compensation based on a factor that is a proxy for a 
transaction's terms or conditions. For example, a consumer's credit 
score or similar representation of credit risk, such as the 
consumer's debt-to-income ratio, is not one of the transaction's 
terms or conditions. However, if a loan originator's compensation 
varies in whole or in part with a factor that serves as a proxy for 
loan terms or conditions, then the originator's compensation is 
based on a transaction's terms or conditions. To illustrate, assume 
that consumer A and consumer B receive loans from the same loan 
originator and the same creditor. Consumer A has a credit score of 
650, and consumer B has a credit score of 800. Consumer A's loan has 
a 7 percent interest rate, and consumer B's loan has a 6\1/2\ 
percent interest rate because of the consumers' different credit 
scores. If the creditor pays the loan originator $1,500 in 
compensation for consumer A's loan and $1,000 in compensation for 
consumer B's loan because the creditor varies compensation payments 
in whole or in part with a consumer's credit score, the originator's 
compensation would be based on the transactions' terms or 
conditions.
    3. Examples of compensation not based on transaction terms or 
conditions. The following are only illustrative examples of 
compensation methods that are permissible (unless otherwise 
prohibited by applicable law), and not an exhaustive list. 
Compensation is not based on the transaction's terms or conditions 
if it is based on, for example:
    i. The loan originator's overall loan volume (i.e., total dollar 
amount of credit extended or total number of loans originated), 
delivered to the creditor.
    ii. The long-term performance of the originator's loans.
    iii. An hourly rate of pay to compensate the originator for the 
actual number of hours worked.
    iv. Whether the consumer is an existing customer of the creditor 
or a new customer.
    v. A payment that is fixed in advance for every loan the 
originator arranges for the creditor (e.g., $600 for every loan 
arranged for the creditor, or $1,000 for the first 1,000 loans 
arranged and $500 for each additional loan arranged).
    vi. The percentage of applications submitted by the loan 
originator to the creditor that result in consummated transactions.
    vii. The quality of the loan originator's loan files (e.g., 
accuracy and completeness of the loan documentation) submitted to 
the creditor.
    viii. A legitimate business expense, such as fixed overhead 
costs.
    ix. Compensation that is based on the amount of credit extended, 
as permitted by Sec.  226.36(d)(1)(ii). See comment 36(d)(1)-9 
discussing compensation based on the amount of credit extended.
    4. Creditor's flexibility in setting loan terms. Section 
226.36(d)(1) does not limit a creditor's ability to offer a higher 
interest rate in a transaction as a means for the consumer to 
finance the payment of the loan originator's compensation or other 
costs that the consumer would otherwise be required to pay directly 
(either in cash or out of the loan proceeds). Thus, a creditor may 
charge a higher interest rate to a consumer who will pay fewer of 
the costs of the transaction directly, or it may offer the consumer 
a lower rate if the consumer pays more of the costs directly. For 
example, if the consumer pays half of the transaction costs 
directly, a creditor may charge an interest rate of 6 percent but, 
if the consumer pays none of the transaction costs directly, the 
creditor may charge an interest rate of 6.5 percent. Section 
226.36(d)(1) also does not limit a creditor from offering or 
providing different loan terms to the consumer based on the 
creditor's assessment of the credit and other transactional risks 
involved. A creditor could also offer different consumers varying 
interest rates that include a constant interest rate premium to 
recoup the loan originator's compensation through increased interest 
paid by the consumer (such as by adding a constant 0.25 percent to 
the interest rate on each loan).
    5. Effect of modification of loan terms. Under Sec.  
226.36(d)(1), a loan originator's compensation may not vary based on 
any of a credit transaction's terms or conditions. Thus, a creditor 
and originator may not agree to set the originator's compensation at 
a certain level and then subsequently lower it in selective cases 
(such as where the consumer is able to obtain a lower rate from 
another creditor). When the creditor offers to extend a loan with 
specified terms and conditions (such as the rate and points), the 
amount of the originator's compensation for that transaction is not 
subject to change (increase or decrease) based on whether different 
loan terms are negotiated. For example, if the creditor agrees to 
lower the rate that was initially offered, the new offer may not be 
accompanied by a reduction in the loan originator's compensation.
    6. Periodic changes in loan originator compensation and 
transactions' terms and conditions. This section does not limit a 
creditor or other person from periodically revising the compensation 
it agrees to pay a loan originator. However, the revised 
compensation arrangement must result in payments to the loan 
originator that do not vary based on the terms or conditions of a 
credit transaction. A creditor or other person might periodically 
review factors such as loan performance, transaction volume, as well 
as current market conditions for originator compensation, and 
prospectively revise the compensation it agrees to pay to a loan 
originator. For example, assume that during the first 6 months of 
the year, a creditor pays $3,000 to a particular loan originator for 
each loan delivered, regardless of the loan terms or conditions. 
After considering the volume of business produced by that 
originator, the creditor could decide that as of July 1, it will pay 
$3,250 for each loan delivered by that particular originator, 
regardless of the loan terms or conditions. No violation occurs even 
if the loans made by the creditor after July 1 generally carry a 
higher interest rate than loans made before that date, to reflect 
the higher compensation.
    7. Compensation received directly from the consumer. The 
prohibition in Sec.  226.36(d)(1) does not apply to transactions in 
which any loan originator receives compensation directly from the 
consumer, in which case no other person may provide any compensation 
to a loan originator, directly or indirectly, in connection with 
that particular transaction pursuant to Sec.  226.36(d)(2). Payments 
to a loan originator made out of loan proceeds are considered 
compensation received directly from the consumer, while payments 
derived from an increased interest rate are not considered 
compensation received directly from the consumer. However, points 
paid on the loan by the consumer to the creditor are not considered 
payments received directly from the consumer whether they are paid 
in cash or out of the loan proceeds. That is, if the consumer pays 
origination points to the creditor and the creditor compensates the 
loan originator, the loan originator may not also receive 
compensation directly from the consumer. Compensation includes 
amounts retained by the loan originator, but does not include 
amounts the loan originator receives as payment for bona fide and 
reasonable third-party charges, such as title insurance or 
appraisals. See comment 36(d)(1)-1.
    8. Record retention. See comment 25(a)-5 for guidance on 
complying with the record retention requirements of Sec.  226.25(a) 
as they apply to Sec.  226.36(d)(1).
    9. Amount of credit extended. A loan originator's compensation 
may be based on the amount of credit extended, subject to certain 
conditions. Section 226.36(d)(1) does not prohibit an arrangement 
under which a loan originator is paid compensation based on a 
percentage of the amount of credit extended, provided the percentage 
is fixed and does not vary with the amount of credit extended. 
However, compensation that is based on a fixed percentage of the 
amount of credit extended may be subject to a minimum and/or maximum 
dollar amount, as long as the minimum and maximum dollar amounts do 
not vary with each credit transaction. For example:
    i. A creditor may offer a loan originator 1 percent of the 
amount of credit extended for all loans the originator arranges for 
the creditor, but not less than $1,000 or greater than $5,000 for 
each loan.
    ii. A creditor may not offer a loan originator 1 percent of the 
amount of credit extended for loans of $300,000 or more, 2 percent 
of the amount of credit extended for loans between $200,000 and 
$300,000, and 3 percent of the amount of credit extended for loans 
of $200,000 or less.
    36(d)(2) Payments by persons other than consumer.

[[Page 58537]]

    1. Compensation in connection with a particular transaction. 
Under Sec.  226.36(d)(2), if any loan originator receives 
compensation directly from a consumer in a transaction, no other 
person may provide any compensation to a loan originator, directly 
or indirectly, in connection with that particular credit 
transaction. See comment 36(d)(1)-7 discussing compensation received 
directly from the consumer. The restrictions imposed under Sec.  
226.36(d)(2) relate only to payments, such as commissions, that are 
specific to, and paid solely in connection with, the transaction in 
which the consumer has paid compensation directly to a loan 
originator. Thus, payments by a mortgage broker company to an 
employee in the form of a salary or hourly wage, which is not tied 
to a specific transaction, do not violate Sec.  226.36(d)(2) even if 
the consumer directly pays a loan originator a fee in connection 
with a specific credit transaction. However, if any loan originator 
receives compensation directly from the consumer in connection with 
a specific credit transaction, neither the mortgage broker company 
nor an employee of the mortgage broker company can receive 
compensation from the creditor in connection with that particular 
credit transaction.
    2. Compensation received directly from a consumer. Under 
Regulation X, which implements the Real Estate Settlement Procedures 
Act (RESPA), a yield spread premium paid by a creditor to the loan 
originator may be characterized on the RESPA disclosures as a 
``credit'' that will be applied to reduce the consumer's settlement 
charges, including origination fees. A yield spread premium 
disclosed in this manner is not considered to be received by the 
loan originator directly from the consumer for purposes of Sec.  
226.36(d)(2).
    36(d)(3) Affiliates.
    1. For purposes of Sec.  226.36(d), affiliates are treated as a 
single ``person.'' The term ``affiliate'' is defined in Sec.  
226.32(b)(2). For example, assume a parent company has two mortgage 
lending subsidiaries. Under Sec.  226.36(d)(1), subsidiary ``A'' 
could not pay a loan originator greater compensation for a loan with 
an interest rate of 8 percent than it would pay for a loan with an 
interest rate of 7 percent. If the loan originator may deliver loans 
to both subsidiaries, they must compensate the loan originator in 
the same manner. Accordingly, if the loan originator delivers the 
loan to subsidiary ``B'' and the interest rate is 8 percent, the 
originator must receive the same compensation that would have been 
paid by subsidiary A for a loan with a rate of either 7 or 8 
percent.
    36(e) Prohibition on steering.
    1. Compensation. See comment 36(d)(1)-1 for guidance on 
compensation that is subject to Sec.  226.36(e).
    Paragraph 36(e)(1).
    1. Steering. For purposes of Sec.  226.36(e), directing or 
``steering'' a consumer to consummate a particular credit 
transaction means advising, counseling, or otherwise influencing a 
consumer to accept that transaction. For such actions to constitute 
steering, the consumer must actually consummate the transaction in 
question. Thus, Sec.  226.36(e)(1) does not address the actions of a 
loan originator if the consumer does not actually obtain a loan 
through that loan originator.
    2. Prohibited conduct. Under Sec.  226.36(e)(1), a loan 
originator may not direct or steer a consumer to consummate a 
transaction based on the fact that the loan originator would 
increase the amount of compensation that the loan originator would 
receive for that transaction compared to other transactions, unless 
the consummated transaction is in the consumer's interest.
    i. In determining whether a consummated transaction is in the 
consumer's interest, that transaction must be compared to other 
possible loan offers available through the originator, if any, and 
for which the consumer was likely to qualify, at the time that 
transaction was offered to the consumer. Possible loan offers are 
available through the loan originator if they could be obtained from 
a creditor with which the loan originator regularly does business. 
Section 226.36(e)(1) does not require a loan originator to establish 
a business relationship with any creditor with which the loan 
originator does not already do business. To be considered a possible 
loan offer available through the loan originator, an offer need not 
be extended by the creditor; it need only be an offer that the 
creditor likely would extend upon receiving an application from the 
applicant, based on the creditor's current credit standards and its 
current rate sheets or other similar means of communicating its 
current credit terms to the loan originator. An originator need not 
inform the consumer about a potential transaction if the originator 
makes a good faith determination that the consumer is not likely to 
qualify for it.
    ii. Section 226.36(e)(1) does not require a loan originator to 
direct a consumer to the transaction that will result in a creditor 
paying the least amount of compensation to the originator. However, 
if the loan originator reviews possible loan offers available from a 
significant number of the creditors with which the originator 
regularly does business, and the originator directs the consumer to 
the transaction that will result in the least amount of creditor-
paid compensation for the loan originator, the requirements of Sec.  
226.36(e)(1) are deemed to be satisfied. In the case where a loan 
originator directs the consumer to the transaction that will result 
in a greater amount of creditor-paid compensation for the loan 
originator, Sec.  226.36(e)(1) is not violated if the terms and 
conditions on that transaction compared to the other possible loan 
offers available through the originator, and for which the consumer 
likely qualifies, are the same. A loan originator who is an employee 
of the creditor on a transaction may not obtain compensation that is 
based on the transaction's terms or conditions pursuant to Sec.  
226.36(d)(1), and compliance with that provision by such a loan 
originator also satisfies the requirements of Sec.  226.36(e)(1) for 
that transaction with the creditor. However, if a creditor's 
employee acts as a broker by forwarding a consumer's application to 
a creditor other than the loan originator's employer, such as when 
the employer does not offer any loan products for which the consumer 
would qualify, the loan originator is not an employee of the 
creditor in that transaction and is subject to Sec.  226.36(e)(1) if 
the originator is compensated for arranging the loan with the other 
creditor.
    iii. See the commentary under Sec.  226.36(e)(3) for additional 
guidance on what constitutes a ``significant number of creditors 
with which a loan originator regularly does business'' and guidance 
on the determination about transactions for which ``the consumer 
likely qualifies.''
    3. Examples. Assume a loan originator determines that a consumer 
likely qualifies for a loan from Creditor A that has a fixed 
interest rate of 7 percent, but the loan originator directs the 
consumer to a loan from Creditor B having a rate of 7.5 percent. If 
the loan originator receives more in compensation from Creditor B 
than the amount that would have been paid by Creditor A, the 
prohibition in Sec.  226.36(e) is violated unless the higher-rate 
loan is in the consumer's interest. For example, a higher-rate loan 
might be in the consumer's interest if the lower-rate loan has a 
prepayment penalty, or if the lower-rate loan requires the consumer 
to pay more in up-front charges that the consumer is unable or 
unwilling to pay or finance as part of the loan amount.
    36(e)(2) Permissible transactions.
    1. Safe harbors. A loan originator that satisfies Sec.  
226.36(e)(2) is deemed to comply with Sec.  226.36(e)(1). A loan 
originator that does not satisfy Sec.  226.36(e)(2) is not subject 
to any presumption regarding the originator's compliance or 
noncompliance with Sec.  226.36(e)(1).
    2. Minimum number of loan options. To obtain the safe harbor, 
Sec.  226.36(e)(2) requires that the loan originator present loan 
options that meet the criteria in Sec.  226.36(e)(3)(i) for each 
type of transaction in which the consumer expressed an interest. As 
required by Sec.  226.36(e)(3)(ii), the loan originator must have a 
good faith belief that the options presented are loans for which the 
consumer likely qualifies. If the loan originator is not able to 
form such a good faith belief for loan options that meet the 
criteria in Sec.  226.36(e)(3)(i) for a given type of transaction, 
the loan originator may satisfy Sec.  226.36(e)(2) by presenting all 
loans for which the consumer likely qualifies and that meet the 
other requirements in Sec.  226.36(e)(3) for that given type of 
transaction. A loan originator may present to the consumer any 
number of loan options, but presenting a consumer more than four 
loan options for each type of transaction in which the consumer 
expressed an interest and for which the consumer likely qualifies 
would not likely help the consumer make a meaningful choice.
    36(e)(3) Loan options presented.
    1. Significant number of creditors. A significant number of the 
creditors with which a loan originator regularly does business is 
three or more of those creditors. If the loan originator regularly 
does business with fewer than three creditors, the originator is 
deemed to comply by obtaining loan options from all the creditors 
with which it regularly does business. Under Sec.  226.36(e)(3)(i), 
the loan originator must obtain loan options from a significant 
number of creditors with which the loan

[[Page 58538]]

originator regularly does business, but the loan originator need not 
present loan options from all such creditors to the consumer. For 
example, if three loans available from one of the creditors with 
which the loan originator regularly does business satisfy the 
criteria in Sec.  226.36(e)(3)(i), presenting those and no options 
from any other creditor satisfies that section.
    2. Creditors with which loan originator regularly does business. 
To qualify for the safe harbor in Sec.  226.36(e)(2), the loan 
originator must obtain and review loan options from a significant 
number of the creditors with which the loan originator regularly 
does business. For this purpose, a loan originator regularly does 
business with a creditor if:
    i. There is a written agreement between the originator and the 
creditor governing the originator's submission of mortgage loan 
applications to the creditor;
    ii. The creditor has extended credit secured by a dwelling to 
one or more consumers during the current or previous calendar month 
based on an application submitted by the loan originator; or
    iii. The creditor has extended credit secured by a dwelling 
twenty-five or more times during the previous twelve calendar months 
based on applications submitted by the loan originator. For this 
purpose, the previous twelve calendar months begin with the calendar 
month that precedes the month in which the loan originator accepted 
the consumer's application.
    3. Lowest interest rate. To qualify under the safe harbor in 
Sec.  226.36(e)(2), for each type of transaction in which the 
consumer has expressed an interest, the loan originator must present 
the consumer with loan options that meet the criteria in Sec.  
226.36(e)(3)(i). The criteria are: The loan with the lowest interest 
rate; the loan with the lowest total dollar amount for discount 
points and origination points or fees; and a loan with the lowest 
interest rate without negative amortization, a prepayment penalty, a 
balloon payment in the first seven years of the loan term, shared 
equity, or shared appreciation, or, in the case of a reverse 
mortgage, a loan without a prepayment penalty, shared equity, or 
shared appreciation. To identify the loan with the lowest interest 
rate, for any loan that has an initial rate that is fixed for at 
least five years, the loan originator shall use the initial rate 
that would be in effect at consummation. For a loan with an initial 
rate that is not fixed for at least five years:
    i. If the interest rate varies based on changes to an index, the 
originator shall use the fully-indexed rate that would be in effect 
at consummation without regard to any initial discount or premium.
    ii. For a step-rate loan, the originator shall use the highest 
rate that would apply during the first five years.
    4. Transactions for which the consumer likely qualifies. To 
qualify under the safe harbor in Sec.  226.36(e)(2), the loan 
originator must have a good faith belief that the loan options 
presented to the consumer pursuant to Sec.  226.36(e)(3) are 
transactions for which the consumer likely qualifies. The loan 
originator's belief that the consumer likely qualifies should be 
based on information reasonably available to the loan originator at 
the time the loan options are presented. In making this 
determination, the loan originator may rely on information provided 
by the consumer, even if it subsequently is determined to be 
inaccurate. For purposes of Sec.  226.36(e)(3), a loan originator is 
not expected to know all aspects of each creditor's underwriting 
criteria. But pricing or other information that is routinely 
communicated by creditors to loan originators is considered to be 
reasonably available to the loan originator, for example, rate 
sheets showing creditors' current pricing and the required minimum 
credit score or other eligibility criteria.
* * * * *

    By order of the Board of Governors of the Federal Reserve 
System, September 1, 2010.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 2010-22161 Filed 9-23-10; 8:45 am]
BILLING CODE 6210-01-P