Case Study 13.1 — The Anti-Steering Safe Harbor: How the Law Answered a Structure Problem

Type: Real, public — federal statute and regulation. Sources: the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010), Title XIV; the Truth in Lending Act and Regulation Z, including the Loan Originator Compensation provisions at 12 CFR 1026.36; Federal Reserve Board and Consumer Financial Protection Bureau rulemaking. Tier 1. Any file illustration below is constructed and labeled. Verify the current text of the rule and its official commentary with your compliance department; requirements change.

Background: a pricing mechanism that paid for the wrong answer

Everything in Chapter 13 assumes the originator is indifferent between the columns on the comparison sheet. For a long stretch of American mortgage lending, that assumption was structurally false, and the way it was false is worth understanding precisely — because the rule that fixed it is written in the shape of the problem.

Recall the rate sheet in §13.4. Every rate has a price. Rates above par carry a price above 100, meaning the loan is worth more than its face amount, and that excess has to go somewhere. On a retail loan it can become a lender credit to the borrower. In the wholesale channel, before the current rules, it commonly became compensation to the mortgage broker — the yield spread premium, paid by the wholesale lender for delivering a loan at an above-par rate.

Read that mechanism against §13.5 and the problem announces itself. The borrower's decision between 6.750% at par and 7.000% with a credit is supposed to be a horizon question: take the money now and pay \$61.09 a month forever, or don't. But if the money from the above-par rate flows to the person advising on the decision rather than to the borrower, the advisor is no longer neutral. Two structures that should be equally acceptable to the originator are not, and the difference is paid by a household that cannot see it.

This is not a claim that every broker steered. Yield spread premium had a legitimate function: it let a borrower with no cash finance their closing costs through the rate, which is a real service and one the modern lender credit still performs. The problem was structural, not moral. A compensation system that pays more for one column of the comparison sheet than another will, across millions of transactions, produce more of that column — regardless of the intentions of any individual originator. That is what "structural" means, and it is why the answer was a rule rather than an ethics seminar.

Compounding it, the pre-crisis rate sheet had rows the Linden Street grid does not. Payment-option adjustable-rate mortgages with negative amortization, interest-only periods, prepayment penalties, and two-year fixed periods on thirty-year notes all priced differently from a plain fixed loan — and frequently priced better for whoever placed them.

The issue: what Congress and the regulators actually chose to prohibit

Title XIV of the Dodd-Frank Act added new loan originator provisions to the Truth in Lending Act. The implementing rule — issued by the Federal Reserve Board and now administered by the CFPB at 12 CFR 1026.36 — did two distinct things, and keeping them distinct is the difference between understanding the rule and reciting it.

First, it attacked the incentive directly. Loan originator compensation generally may not be based on a term of a transaction — not the interest rate, not the presence of a prepayment penalty, not the product type. Compensation on a permissible basis such as loan amount is treated differently, and the rule addresses dual compensation, proxies for terms, and the circumstances in which an originator may reduce compensation to bear the cost of a pricing concession. The compensation provisions are Chapter 26's subject and you should read that chapter before forming any opinion about your own comp plan.

Second, and separately, it prohibited steering. A loan originator may not direct or "steer" a consumer to consummate a transaction based on the fact that the originator will receive greater compensation from that transaction than from other transactions the originator could have offered, unless the transaction is in the consumer's interest.

Notice the shape of that prohibition. It does not forbid recommending. It does not require the originator to be silent or to present every product in existence. It forbids letting the originator's own economics decide which structure a borrower ends up in. That is exactly the line §13.9 draws, and the rule got there first.

The safe harbor: a rule written as a comparison sheet

The provision most relevant to this chapter is the safe harbor, because it describes a document rather than a state of mind — and a document can be produced, reviewed, and kept.

An originator is generally deemed not to have steered where, for each type of transaction in which the consumer expressed an interest, the originator presents loan options that satisfy the following, and the originator has a good-faith belief the consumer likely qualifies for them:

1. The loan with the lowest interest rate.
2. The loan with the lowest interest rate without certain risky features — negative amortization, a prepayment penalty, interest-only payments, a balloon payment in the first seven years, a demand feature, shared equity, or shared appreciation.
3. The loan with the lowest total dollar amount of origination points or fees and discount points.

The options are to be drawn from a significant number of the creditors with which the originator regularly does business, and the rule and its commentary set out how that quantity is measured and how an originator who regularly does business with only a small number of creditors complies. Verify the current text and commentary — this is exactly the kind of detail that gets amended.

Read the three required options again and notice what they are. They are a comparison sheet. Option 1 is the lowest payment. Option 3 is the lowest cash to close. Option 2 is the structure whose payment will not change in a way the borrower did not expect. The regulation's answer to steering is to require the originator to show the borrower the trade-off — precisely the four units §13.9 asks you to quantify, arrived at by a completely different route.

What it shows

The rule assumes the borrower decides. Nothing in it asks the originator to select the best loan. It asks the originator to lay out real alternatives and to have not tilted the field. A loan officer who has internalized §13.9's five-step discipline satisfies the substance of this rule almost incidentally, which is the point of writing the chapter that way.

Compliance and craft converge here, and they do not always. Elsewhere in this book you will find rules that impose real cost for real reasons without making anyone better at the job. This is not one of them. The originator who builds Figure 13.2 for every file is faster, more persuasive, and more referable than the one who does not, and is also documented.

The safe harbor is about channel as much as conduct. The "significant number of creditors" element speaks most directly to an originator who can place a file with more than one creditor. A retail originator working from a single employer's menu satisfies it differently — but the prohibition on steering applies to every originator in every channel, and the absence of a menu is not an absence of choices. A retail file still has a program decision, a down-payment decision, and six rows of a rate sheet.

A separate and independent obligation runs alongside it. Presenting different options, or different levels of effort, to similarly situated applicants on a prohibited basis violates the Equal Credit Opportunity Act and Regulation B and the Fair Housing Act, and requires no compensation motive at all. Chapter 25 is the authority. Two originators could both satisfy the anti-steering safe harbor and one of them could still be running a fair-lending violation.

Outcome

The compensation and anti-steering provisions took effect in 2011 and were subsequently amended and recodified as the CFPB assumed rulewriting authority. The yield spread premium as a broker compensation mechanism did not survive them in its old form; the lender credit — the same pricing mechanic, flowing to the borrower instead — did, and is on every rate sheet in the country including Figure 13.1.

The market did not become simple. Loan officers are still paid on closed volume, which is itself an incentive the rule does not remove and does not pretend to. But the specific mechanism by which a borrower's rate could quietly fund the advice they received about their rate is gone, and the comparison document the rule describes has become ordinary practice.

The lesson

A rule that requires you to show the borrower the trade-off is not a burden on advice. It is a description of what advice is.

The originator who resents the anti-steering provisions has usually misread them as a prohibition on recommending. They are not. Refusing to recommend is not neutrality — it is abandonment with a compliance rationale. Say what you would do, say why, name the fact that would change your mind, put both columns on the same page in the same size type, and let the borrower choose.

On the Linden Street file that discipline produced a recommendation against the structure with the lower monthly payment, in favor of the one that cost \$25,382.19 less over thirty years — and the borrowers made the decision themselves, on numbers they could check, on day 15.

Discussion questions

1. The chapter argues the pre-crisis problem was structural rather than moral. Do you accept that framing? What would change if you concluded the problem was primarily moral — would the remedy look different?

2. The safe harbor's three required options are, in effect, "lowest rate," "lowest rate without risky features," and "lowest points and fees." Which of the four units §13.9 asks you to quantify — payment, cash to close, reserves, total cost over a horizon — is missing from that list? Why might a regulation have left it out, and what does its absence cost a borrower?

3. A retail originator with a single employer's product menu says the anti-steering safe harbor "does not really apply to me." Evaluate that statement. What still applies, and what would you want to see in that originator's file?

4. Yield spread premium and the modern lender credit are the same pricing mechanic pointed at different recipients. Is there any circumstance in which the older arrangement served a borrower better? Defend your answer with the arithmetic from §13.5.

5. Suppose your compensation is identical across every structure you can offer. Does the anti-steering provision still constrain you? Should it? Separately: does anything else in this chapter still constrain you?

6. Write the one-sentence test you would apply to your own recommendation on any file, before you say it out loud, to know whether you have steered.