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Moody’s Expects New Originator Compensation Rules to Lower Defaults

In mid-August, the Federal Reserve published a ""list of new rules"":http://dsnews.comarticles/fed-issues-new-mortgage-disclosure-and-compensation-rules-2010-08-16 that officials say are intended to protect consumers from abusive and deceptive mortgage lending practices. Among the regulations are explicit restrictions on how mortgage brokers and loan officers can be compensated, which go into effect April 1, 2011.

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In a research note issued Tuesday, ""Moody's Investors Service"":http://www.moodys.com offered a detailed analysis of the impending payment requirements, which prohibit loan originators from double-charging for origination fees and bar them from steering borrowers toward less-than-optimal mortgage products in return for higher compensation.

""From a credit standpoint, these changes, will likely lower rates and fees for borrowers, translating into lower probability of default on mortgage loans,"" according to Moody's analysts.

The credit ratings agency explained that typically, loan originators' compensation from lenders, also referred to as yield spread premiums (YSPs), represents the difference between the interest rate charged to the borrower and the minimum rate at which the borrower could have qualified for the loan under the lender's underwriting and pricing guidelines.

The new rules prohibit compensation based on the YSP, which Moody's says eliminates the originator's incentive to charge higher rates beyond what is justified by the borrower's risk profile.

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""We expect rates to be lower as a result of the elimination of commercially motivated overcharges,"" Moody's said in its commentary. ""Lower rates should result in lower payments, which would translate, all else being equal, into lower defaults, a credit positive.""

In addition, the company's analysts contend that putting an end to double-charging for origination fees is likely to improve competitiveness.

The new rules will no longer permit mortgage brokers or loan officers to charge both the borrower and the lender an origination fee for the same loan. As a result, Moody's says some borrowers' monthly payments will include fewer add-ons in the form of amortized points and fees.

""When this rule becomes effective, we expect that in competitive market segments, lenders will pay the origination fees in the form of commissions rather than having them paid by borrowers in the form of points and fees,"" the company said.

Moody's asserts that in competitive markets where the rate is paramount, any additional points and fees charged to the borrower would hurt the competitive position of the originator.

In addition, Moody's says it believes the prohibition of steering will enhance customers' ability to pick products that are more suited to them, which, in turn, should also lower their probability of default.

Previously, loan originators could encourage a borrower to take a mortgage with unfavorable terms or unnecessarily risky features in order to bolster their own compensation, the company explained, but the new rule prohibits steering.

Moody's notes that it also creates a safe harbor for originators as long as they disclose to the borrower the lowest-interest-rate mortgage product for which they qualify, the mortgage product that minimizes points and origination fees, and the mortgage product that has the lowest rate and does not include such features as prepayment penalties or negative amortization.

About Author: Carrie Bay

Carrie Bay is a freelance writer for DS News and its sister publication MReport. She served as online editor for DSNews.com from 2008 through 2011. Prior to joining DS News and the Five Star organization, she managed public relations, marketing, and media relations initiatives for several B2B companies in the financial services, technology, and telecommunications industries. She also wrote for retail and nonprofit organizations upon graduating from Texas A&M University with degrees in journalism and English.
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