Is It Time to Change the Mortgage Broker Model?

November 22, 2010

Mortgage brokers are an endangered species. Before the financial crisis, they touched almost 3 of every 4 new mortgages. Today, it is closer to 1 of 4, and still declining.

 Decline in Market Share of Mortgage Brokers

The causes are many and include the post-crisis swing to FHA loans, which many brokers aren’t eligible to handle, and new disclosure and licensing regulations that put brokers at a disadvantage. In addition, their public esteem and political clout have suffered from the bad press associated with their role in the market frenzy that preceded the financial crisis.

To some degree, brokers have gotten a bum rap, since they had nothing to do with the erosion of underwriting standards that paved the way for the crisis. However, they were eager participants who profited from the frenzy, and their pricing policies have long been suspect.

Many observers say “good riddance”, but I don’t share that view. Aside from dysfunctional pricing, which can be remedied (see below), mortgage brokerage is the quintessential small business, offering attractive opportunities to energetic self-starters who like to be their own bosses and reap the full rewards of their own efforts. Furthermore, mortgage brokers and the independent wholesale lenders that service them are a competitive counterweight to the few mega-retail banks that now dominate the post-crisis mortgage market. For this reason alone, we need brokers now more than ever.

The Existing Concealment Pricing System Is Dysfunctional

Dysfunctional pricing has played a major role in the industry’s loss of public esteem. Lenders deliver wholesale prices to brokers who add markups before quoting retail prices to borrowers. Lenders do not publicly disclose their wholesale prices. With the exception of Upfront Mortgage Brokers, brokers don’t disclose them either, since that would be tantamount to disclosing their markups, which most brokers view as nobody’s business but theirs.

This is a system of concealment that allows brokers to price opportunistically, charging what they think the borrower might be willing to pay. The concealment system breeds distrust. The industry will never regain its good standing in the market until it replaces this system of concealment with a system of transparency.

 Advantages of a Transparent Pricing System

A transparent pricing system requires full participation by wholesale lenders as well as brokers. Under a transparent system, wholesale lenders quote retail prices available to borrowers through brokers. These prices are public information, and the lenders can advertise them and disclose them on their web sites, just as retail lenders do. The only difference is that the mortgages advertised by the wholesale lenders are available only through brokers. Borrowers who seek a price posted by a wholesale lender know that they can obtain that price from any broker dealing with that lender.

In the transparent system, the broker is paid by the lender and has no control whatever over the mortgage price. Brokers compete in terms of service, reputation, personality, expertise, sex appeal, anything but price. Lenders will develop standardized pricing formulas for compensating brokers. The broker can also charge the borrower, but the charge is disclosed at their first meeting, before the borrower is committed.

The broker in a transparent pricing system is not in a conflict situation with the borrower, as is the case in a concealment system. This largely eliminates distrust. It also ends needless and time-consuming shopping by borrowers, who flit from one broker to another looking for a better price, not realizing that the broker quoting the lowest price may have no intention of delivering it.

Brokers will make less on each loan in a transparent system, but they will do more loans because they will waste less time on deals that don’t close. Lenders will be able to market directly to borrowers, and will no longer be vulnerable to lawsuits from borrowers who were grossly overcharged by predatory brokers.  

Broker Pricing Abroad Is Transparent 

These benefits of a transparent system are not hypothetical. Such systems exist in Canada, the UK and Ireland, whereas to my knowledge, the US is the only country in the world that uses a system of concealment.

I wrote an article about the UK system in 2008, and reported that the fees paid to brokers there were less than half as large as those in the US. In the UK, furthermore, brokers are relationship oriented, because with price out of the picture, establishing a relationship with the borrower is a strategy for getting referrals and repeat business.

In the US, brokers who look to make as much as they can on every deal are by definition transaction oriented. The few who are not, including Upfront Mortgage Brokers (UMBs), standardize their pricing and disclose it. They practice transparency within a concealment system.

To make transparency system-wide requires that a core group of wholesale lenders switch to a transparency model. This requires that the lenders quote retail prices publicly, offer mortgages at those prices through brokers who switch to this model, and develop price schedules for compensating brokers. I’m prepared to help in any way I can, including promoting them as “Upfront Wholesale Lenders”.

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