Loan Segregation of Duties
From time to time, we get questions about segregation of duties and conflicts of interest for mortgage loan originators (MLOs). Today’s blog is going to provide an overview of the regulations related to what is or isn’t prohibited when it comes to the duties of an MLO. Additionally, what conflicts may arise if a loan originator performs most, if not all, of the duties in the loan process.
What are the duties of a mortgage loan originator?
Regulation Z states that a loan originator is defined as “a person who, in expectation of direct or indirect compensation or other monetary gain or for direct or indirect compensation or other monetary gain, performs any of the following activities: takes an application, offers, arranges, assists a consumer in obtaining or applying to obtain, negotiates, or otherwise obtains or makes an extension of consumer credit for another person…”
The above regulation provides what a mortgage loan originator’s duties are and doesn’t necessarily prohibit a loan originator from having additional duties.
Can a mortgage loan officer underwrite and process the loan as well?
While there is no specific federal regulation which prohibits a mortgage loan originator from taking a loan application, underwriting, and processing it, there may be issues with a potential conflict of interest or possible fair lending issue that could result. This may occur when one person is performing all the duties on a loan since an originator has a vested interest in approving the loan and presents a larger risk for manipulation of data or mistakes to be made. Consequently, many financial institutions segregate these functions as an internal control from a credit union lending policy or supervisory committee audit perspective.
Compensation could also be a conflict of interest issue depending on how a mortgage loan originator is paid for originating a loan versus underwriting a loan. Regulation Z, section 1026.36(d) prohibits certain payments to loan originators, such as dual compensation. Having a mortgage loan officer approve a mortgage they originated increases the potential of such prohibited payments.
Additionally, if the loan is sold in the secondary market or part of a government program, a credit union may want to review Fannie Mae, Freddie Mac and government-secured lending guidelines to determine whether it is permissible for a mortgage loan originator to underwrite the loan and receive dual compensation or incentives for those loans that are closed. For example, Under HUD’s FHA Single Family Housing Policy Handbook:
“Conflicts of Interest
Employees are prohibited from having multiple roles in a single FHA-insured transaction and are prohibited from having multiple sources of compensation, either directly or indirectly, from a single FHA- insured transaction.”
NCUA has also published Legal Opinion Letters here and here on this topic which reiterate that segregation of lending duties is crucial to minimize risk and ensure there is proper oversight.
Lastly, a credit union may want to check their policies, bylaws and code of ethics to see if there are any prohibitions of duties. Alternatively, a credit union has the option of creating a credit committee to review the loans and determine if they should be approved. In order to do this, a credit union may want to review its own bylaws or NCUA’s Model Bylaws for information on the formation of this type of committee. Specifically, Article VIII of the Model Bylaws provides that the credit committee is responsible for reviewing and approving loans. This includes reviewing each application, determining the member's ability to repay the loan and establishing the appropriate security for the loan, if necessary.
Can a mortgage loan originator disperse the funds on the loan?
The FCU Act is clear that a loan officer cannot disburse the funds on the loan that he or she approved. Specifically, the FCU Act provides that “no individual shall have authority to disburse funds of the Federal credit union with respect to any loan or line of credit for which the application has been approved by him in his capacity as a loan officer.” As such, loan officers are strictly prohibited from the activity of disbursement of funds.
Ultimately, a credit union may need to make a risk-based decision regarding a mortgage loan originator taking on any additional duties.
As always, compliance questions can be sent to our Compliance Team at compliance@americascreditunions.org.
