Are Mortgage Brokers Like Car Dealers?

March 5, 2001

"My cousin financed his car through the car dealer and is now involved in a class action suit against the lender… As I read about how car dealers arrange financing, it strikes me that they operate just like mortgage brokers. Am I right?"

Largely. While there are many differences between mortgage brokers and the financing arm of car dealers, these are less important than the similarities. The potential for abuse is essentially the same. Class action suits against lenders in both industries make essentially the same allegation: that the lenders allowed the dealers/brokers to collect excessive charges from the borrower.

Both car dealers and mortgage brokers are loan finders; they do not lend their own money. Both maintain relationships with multiple lenders. The major service they provide to the consumer is accessing lenders.

One difference is that mortgage brokers usually deal only with mortgages while dealers also offer such “extras” as accident and health insurance, life insurance and warranties. A second difference is that finding the right loan is usually much more work for a mortgage broker. There are many more loan programs and options from which to choose, and the qualification requirements and pricing are much more complex.

Both brokers and dealers receive competitive prices from lenders, who must compete with each other for their business. This part of the market process works well.

Both brokers and dealers add a markup to the wholesale price, which is what they make on the deal. This part of the market process does not work nearly as well.

The broker marks up the points. Points are an upfront charge expressed as a percent of the loan; one point is 1% of the loan. For example, if the lender quotes 8% and 1 point on a $200,000 loan and the broker adds 1 point, the borrower pays a total of $4,000, of which $2,000 goes to the broker.

Car dealers mark up the interest rate, but are paid for the higher rate by the lender as if the rate increase was points. For example, if the lender quotes a 12% rate on a $20,000 car loan and the dealer marks it up to 14%, the lender will pay the dealer 2% of $20,000, less a small reserve that the lender retains to cover early repayments.

The markup process has significant potential for abuse in both markets. While some brokers/dealers try to standardize their markups, others charge as much as they can get away with in each case. The result is that markups vary widely, and the variations have little to do with the amount of work required of the broker or dealer.

Most brokers and dealers try to keep their markups to themselves. Mortgage brokers are required by law to disclose their markups, but usually this happens too late in the lending process to do the borrower any good. Car dealers need not disclose their markups ever.

Both brokers and dealers feel it is unjust to require them to disclose markups. “Grocery stores need not disclose their markups, so why should we?” Their argument overlooks that consumers become expert at shopping for groceries because they do it so frequently, and prices are easily compared between stores. Consumers take mortgage loans and automobile loans infrequently, and shopping alternatives is difficult.

Nonetheless, alert consumers can avoid excess markups. Consumers in both markets can check quoted prices for reasonableness on the internet. Borrowers in the car loan market can use the Annual Percentage Rate (APR), a comprehensive measure of the cost of credit, as an effective shopping comparison tool. Interest rates on car loans are also much more stable than mortgage loan rates. But borrowers must resist the temptation to go from the automobile table to the loan table without exploring other loan options.

Shopping mortgages is more difficult because the market changes so frequently and pricing is much more complex. Furthermore, borrowers can’t depend on the APR as a guide unless they confidently expect to be in their house at least 10 years. Borrowers can avoid these problems, however, by retaining an Upfront Mortgage Broker (UMB) who discloses the markup in advance, and then acts as the agent of the borrower in finding the best deal. For a list of UMBs, click here

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