Seller Credits and Prohibited Dual Compensation

In Regulation Z there is found 12 CFR § 1026.36, an unusual section that discusses payment processing, loan originator compensation, steering, and prohibitions on mandatory arbitration clauses, to name a few. Among this hodge-podge is found the prohibition against dual compensation for loan originators.

As part of the larger discussion on loan originator compensation, 1026.36(d) focuses more on ways in which a loan originator may NOT be compensated, rather than the various ways in which they may be compensated. Regulations in general normally work the other way around: the regulation tells you what you must do, and everything else (if not prohibited) is acceptable. In this case, the regulation focuses primarily on what you cannot do.

The loan originator compensation rule applies to closed-end consumer loans secured by a dwelling, and has two major prohibitions: 1) payments based on a term of the transaction, and 2) payments by persons other than the borrower (i.e., dual compensation). In the first prohibition, the rule prohibits loan originators from being compensated on the term of the transaction, or proxy of a term of the transaction, where the transaction is one or more consumer mortgage loans. On the surface this prohibition seems simple – you’re not allowed to pay a higher compensation for a higher interest rate or pay out a higher commission on an ARM loan vs a fixed-rate loan. Because it can get a little more complex than it initially seems check out our Loan Originator Compensation Webinar and Manual if you want to know more about this prohibition.

The second prohibition for loan originators is a prohibition on payments by persons other than the borrower (i.e., dual compensation). As Regulation Z explains it, if any loan originator receives compensation directly from a borrower for a loan secured by a dwelling, then the loan originator is prohibited from receiving compensation from any other person for that transaction.

With the rise in interest rates, we’ve seen creative solutions to buyers’ needs, including an increase in the number of sellers offering to buy down the borrower’s rate using seller credits. The question then arises as to whether this seller credit could represent a violation of the prohibition against dual compensation. In a scenario in which the borrower is buying down the rate, and the seller is also additionally buying down the rate further, is the money from the seller considered compensation received from someone other than the consumer?

Probably not, but it could be under the right circumstances. Concerning the idea of receiving compensation “directly from the borrower,” Regulation Z counterintuitively broadens this concept to include payments not just from the borrower, but payments from others also. Payments made due to an agreement between the borrower and another person, in which the other person agrees to pay some of the borrower’s loan costs is consider being paid “directly by the borrower.” In our above example with a seller providing a credit to buy down the borrower’s rate, if there is an agreement between the borrower and seller that the seller will provide a credit towards the borrower’s closing costs, then these funds paid by the seller are considered to be paid directly by the borrower.

As the regulation states in 1026.36(d)(2)(i)(B): “Compensation received directly from a consumer includes payments to a loan originator made pursuant to an agreement between the consumer and a person other than the creditor or its affiliates, under which such other person agrees to provide funds toward the consumer’s costs of the transaction…” However, if no agreement exists between the borrower and seller in which the seller agrees to pay some of the borrower’s loan costs, then the expansion of compensation paid “directly by a borrower” would not apply to these seller payments, and such payments by the seller could violate the dual compensation provision in 1026.36.