Should Brokers Decide For Borrowers?

April 5 , 2004, October 31, 2008

“I am a mortgage broker. I've done many loans for clients by using the lender's rebate to pay my fee and other closing costs. True, the rate the borrower pays is higher but my customers are spared significant out-of-pocket expenses. What is your view of this strategy?”

It is OK so long as the borrower knows what you are doing and chooses to compensate you and cover other closing costs in that way. But the decision should be the borrower’s, not yours.

Wholesale lenders offer numerous combinations of interest rate and points, including positive points and negative points or rebates. For example, on a 30-year fixed-rate mortgage, the lender might quote 5.5% at zero points, 5.25 % at 1.5 points, and 5.875% at a rebate of 1.5 points. Suppose the broker is looking to make 1.5 points on the deal. Then the borrower who elects to pay 5.5% must pay the broker 1.5 points in cash but the borrower who pays 5.875% has the broker’s fee paid by the lender.

Although there are no statistics on this, my impression is that a large proportion of borrowers today pay interest rates high enough to command rebates from lenders that at least cover the broker’s fee. Unfortunately, many mortgage brokers make this decision for their clients, whether it is appropriate for them or not. In effect, they tell the borrower “The rate is 5.875% and, good news, you don’t have to pay my fee.” It is a much easier way to do business than wrangling with borrowers over fees.

My objection to this way of doing business is that the broker is depriving the borrower of the opportunity to make a high-yield investment. A borrower who pays 1.5 points to reduce the rate from 5.875% to 5.5% will earn 17.4% return on his investment if he holds the loan for 10 years. If he holds it for only 5 years, he earns 7.4%, which is still pretty good. (These number are taken from calculator 11c, Mortgage Points Calculator: Rate of Return on FRMs.)

The borrower who doesn’t expect to have the mortgage for 5 years is better off avoiding upfront costs by accepting a higher rate. But it should be the borrower’s decision, not the broker’s.

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