A mortgage broker is an independent contractor who offers the loan products of multiple lenders, called wholesalers.
Mortgage brokers do not lend. They counsel borrowers on any problems involved in qualifying for a loan, including credit problems. Brokers also help borrowers select the loan that best meets 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.
Advantages of Dealing with Brokers: Borrowers with special needs do better dealing with a broker. No one lender offers loans in every market 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, who deal with multiple lenders, can find them when needed.
In addition, 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." In addition, brokers keep lenders honest on lender fees specified in dollars, sometimes called "junk fees." Some retail lenders view these fees as an added source of revenue because borrowers often don't know what they are at the time they select the lender. But wholesale lenders don't play this game.
Lenders quote wholesale prices to brokers because of the work that brokers do for them that lenders would otherwise have to do themselves. While there are no published statistics on the wholesale/retail price difference, informed observers say that it averages about 1.5 points.
The price savings to the borrower thus consist of the wholesaleretail 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, the borrower pays less dealing with a broker.
Disadvantages of Dealing with Brokers: A lender will honor a mistake in the customer's favor made by one of its employees, but it 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.
It is not at all clear that an unsophisticated borrower is more likely to be taken advantage of by a broker than by a lender. Predators come from both groups. Lender predators may actually be more difficult to spot because they are subject to less rigorous disclosure rules than brokers. Nonetheless, there are some unscrupulous brokers, and it is very difficult for borrowers to distinguish them from the scrupulous ones.
How Brokers Make Money: The lenders that mortgage brokers deal with quote a "wholesale" price to the broker, leaving it to the broker to add a markup in order to derive the "retail" price offered the consumer. For example, the wholesale price on a particular program might be 7% and zero points, to which the broker adds a markup of one point, resulting in an offer to the customer of 7% and one point. But if the broker adds a two-point markup, the customer would pay 7% and two points.
What determines the markup? Most have a target, sometimes in points (say 1.5 to 2), sometimes in dollars (say $3,000), which they try to adjust to the anticipated workload. Some brokers set the markup in each case as high as they can get away with. An unsophisticated customer who shows no inclination to shop the competition will be charged more than a sophisticated customer who makes clear an intention to shop.
Indeed, mortgage brokers often rationalize the high markups they charge some customers on the grounds that these are needed to offset the excessively small markups they are forced to accept on other deals. Some borrowers do turn the tables on mortgage brokers by threatening to bail out of a deal after most of the work has been completed unless the mortgage broker agrees to cut the price.
How Much Brokers Make: A survey taken in 1998 of about 1,000 broker firms found that the average income per loan was $2,443, which was 2.02% of the average loan amount of $120,744. This is gross income—none of the brokers' expenses are deducted.
A study I did covering 774 loans brokered in December 2000 and January 2001 provides more detailed information on factors affecting mortgage broker income. The brokers covered are larger firms employing multiple loan officers, and they operate in relatively upscale markets. Their average income per loan was $3,191, which was 2.10% of the average loan of $152,031.
Brokers make more money on large loans than on small ones. For loans of $80,000 and less, the brokers averaged $1,600 per loan. For loans greater than $225,000, they averaged $5,453 per loan. Income per loan was higher on FHA loans than on conventional loans. For example, on loans between $80,000 and $110,000, brokers averaged $3,234 on FHAs and $2,093 on conventionals.
The Broker as the Borrower's Agent: 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. But 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.
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 ___________.
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1. Is There a Broker inside You
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