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June 24, 2002
I get tons of mail from
borrowers who are confused about the differences between lenders and mortgage
brokers, and how these differences matter.
"What is a
mortgage broker?"
A mortgage broker is
a loan provider who offers the loan products of different lenders.
"How does a mortgage
broker differ from a lender?"
Mortgage brokers do
not lend money. Most of them are small firms providing services rather than
loans. The lender is the one who provides the money to the borrower at the
closing table. The lender also makes the final decision regarding loan approval.
"What do
mortgage brokers do exactly?"
Mortgage brokers
counsel borrowers on any problems involved in qualifying for a loan, including
credit problems. Brokers also help borrowers select the loan that best meet
their needs, and shop for the best deal among the lenders offering that type of
loan. Brokers take applications from borrowers, and lock the rate and other
terms with lenders. They also provide borrowers with the many disclosures
required by the Federal and state governments.
In addition, brokers
compile all the documents required for transactions, including the credit
report, property appraisal, verification of employment and assets, and so on.
Not until a file is complete is it handed off to the lender, who approves and
funds the loan.
"How do mortgage
brokers make money?"
The lenders that
mortgage brokers deal with quote a "wholesale" price to the broker,
leaving it to the broker to derive the
"retail" price offered the consumer by adding a markup. For example, the wholesale price
on a particular program might be 7% and 0 points, to which the broker adds a
markup of 1 point, resulting in an offer to the customer of 7% and 1 point.
(Each point is equal to one percent of the loan amount). But if the broker adds
a 2 point markup, the customer would pay 7% and 2 points.
"What are
the advantages of dealing with a mortgage broker?"
Their access to loan
programs from many different lenders has two major advantages. First, brokers
are more likely to find a loan that will meet the specialized needs of borrowers
than a single lender.
The market is
subdivided into countless "niches" and no one lender offers loans in
every niche. For example, many lenders won�t offer loans to borrowers with
poor credit, borrowers who can�t document their income, borrowers who can�t
make any down payment, borrowers who want to purchase a condominium as an
investment, borrowers with very high existing debts, borrowers who need to close
within 72 hours, or borrowers who reside abroad. The list goes on and on. But
there are lenders in every one of these niches, and brokers can find them when
needed.
The second advantage
of dealing with a mortgage broker is that brokers are experts at shopping the
market. Brokers are far better positioned than consumers to select the best deal
available from competing lenders on the day the terms of the loan are
"locked".
"Won�t I
pay more than if I go directly to the lender?"
You could pay more, or you
could pay less. Lenders quote wholesale prices to brokers because of the work
that brokers do for them that lenders would otherwise have to do themselves.
Lenders who operate through both wholesale and retail distribution channels
quote wholesale prices well below retail prices.
While there are no published
statistics on the wholesale/retail price difference, informed observers say that
it averages about 1.5 points. On a loan of $100,000, 1.5 points amounts to
$1,500.
In addition to getting a
wholesale price, borrowers benefit from the broker�s superior ability to shop
the market. The broker has ready access to many more lenders with an interest in
a particular transaction than a borrower.
The price savings to the
borrower thus consist of the wholesale-retail price spread plus the savings from
better shopping. On the other side of the ledger is the broker�s fee. If the
price savings exceed the fee, you pay less dealing with a broker.
"Is it ok to
use a mortgage broker to find the right lender, then go directly to that
lender?"
No, that is a sleazy practice
because the broker won�t be compensated for his time, and for the use of his
knowledge and expertise on your behalf. Yet some borrowers try it, which is why
even the most scrupulous brokers keep the identity of the lender concealed until
an application has been submitted.
The borrowers who try an
end-run around the broker usually assume that the lender will offer them the
same price it quoted to the broker, but that is not the case. Lenders who lend
both directly to borrowers and indirectly through brokers have separate retail
and wholesale departments. The borrower who dumps the broker to go directly to
the lender will be directed to the retail department and be offered retail
prices. These could be higher than the price the
borrower would have paid going through the broker.
"Are there
disadvantages in dealing with a mortgage broker rather than a lender?"
Yes. A lender will honor a
mistake in the customer�s favor made by one of its employees, but it probably
won�t honor a mistake made by a mortgage broker. In addition, some borrowers
find comfort in dealing with a large lender with a recognizable name. Brokers
are not known nationally, although they may be well known locally, especially by
the real estate agents from whom they receive referrals.
"Is an
unsophisticated borrower more likely to be taken advantage of by a broker than
by a lender?"
That is not at all clear. We
know that predators come from both groups, but there are no data on how they
break down as between brokers and lenders. It would be unwise to assume that
because you are dealing with a lender, you are safe. Lender predators may
actually be more difficult to spot because they are subject to less rigorous
disclosure rules than brokers.
As an example, a predatory
broker I knew about found his style cramped a bit by rules requiring brokers to
disclose their compensation from lenders. So he joined a "net branch",
a lender firm that allows its loan officer employees to operate pretty much as
if they are independent mortgage brokers. The loan officer, in other words, can
keep most of the profit earned on a customer. This predator now preys on
borrowers as he did before, but as an employee of a lender he no longer needs to
disclose compensation from sources other than the borrower.
"How can an
unsophisticated borrower be sure he is not in the hands of a predator?"
One strategy I recommend is
to find a mortgage broker who is willing to work as your agent. The prevailing
practice is for brokers to operate as independent contractors.
A broker operating
as an independent contractor adds a markup to the wholesale prices received from
lenders, quoting a retail price to the borrower. The borrower doesn�t know
what the markup is. Markups tend to be higher for unsophisticated customers who
show no inclination to shop the competition than for sophisticated customers who
make clear that they intend to shop. Most brokers will cap the markup to even
the most gullible borrowers, but predators respect no limits.
If you retain a broker as
your agent, you pay the broker a fee agreed-upon in advance, which includes your
payment and any compensation the broker receives from the lender. The broker
passes through the wholesale prices, which are disclosed to you, without any
markup.
Implementing this strategy
requires finding a broker prepared to work as your agent for an agreed-upon fee.
A small group of brokers prefer to work in this way. They are Upfront
Mortgage Brokers. But many other brokers would be willing to if
customers requested it.
Successful implementation
requires that the broker�s compensation from your transaction be stipulated at
the outset, in writing, signed by the broker and by you. This avoids
misunderstandings or surprises. The document should state:
"The total compensation
to [name of broker], including any rebates from the lender, will
be:_____________. A separate processing fee will be:______. "
Copyright Jack Guttentag 2002
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