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mortgage brokers

Do mortgage brokers act in their customer’s best interest?

By definition, a broker is a person who arranges or negotiates something like a settlement, deal, or plan. It follows that mortgage brokers arrange or negotiate a mortgage.  But what does “arranges or negotiates” really mean?

More importantly, does a mortgage broker always act in the best interest of their customer, the mortgage borrower?

These questions come up whenever we meet with financial advisors. Understanding the answer (hint: it is not a simple yes or no) is essential for a fiduciary advisor who wants to remain, well, a fiduciary advisor. Failing to understand this answer results in failing to look out for the best interest of your client. 

Let’s examine how mortgage brokers come up with their mortgage rates.

How mortgage brokers come up with rates

A mortgage broker will compare various wholesale lenders when examining loan options for a potential customer.  Wholesale lenders (which have approved the mortgage broker as a partner) will supply rate sheets or the raw data to populate loan pricing software.

In this sense, wholesale lenders are just like wholesale suppliers in a retail market. They can have specialties such as “jumbo loans” and rate or pricing differences will certainly exist amongst them.

The graph below represents the wholesale price from three different wholesalers available to a mortgage broker. For our purposes, we’ll imagine there are just three different wholesale lenders being considered for a particular loan.  Truth is, there could be many more options considered by one mortgage broker.

Mortgage broker wholesale pricing

To grasp the concept of how this process works we are omitting the actual interest rates.  Rather, we are going to focus on their relative position to each other. Note the Y-axis is simply “Interest Rate” and void of specific numbers.

In the case above, Wholesale Lender 1 is offering the lowest wholesale rate given the mortgage customer’s credit, income, and other criteria. In contrast, Wholesale Lender 3 is providing the highest wholesale rate.  Lower rates are always better when other things such as origination fees and discount points are held constant.

With an understanding of the mortgage broker’s “suppliers,” let’s move on to how the mortgage broker makes money.

A mortgage broker adds margin

A mortgage broker will add a retail margin, or markup, to each wholesale rate.  These two items, when combined, determine the final interest rate presented to the mortgage customer.

Industry compliance and several other factors ensure that a specific mortgage broker earns the same markup on each loan they could offer.  As a result, the same margin is added on top of each wholesale rate.

Mortgagebrokeraddsmargin

With the retail margins added to each wholesale price, the relative attractiveness does not change. Wholesale Lender 1 + broker margin is still the most attractive loan option.  Said another way, this wholesale price and the margin combined will result in the lowest rate for the mortgage customer.

A mortgage broker presents their best option

Mortgage brokers want to present their best option to increase their chances of winning the loan business. They are indifferent as to which option they provide because they generate the same margin in all cases. In this sense, a mortgage broker does “shop” rates in some way. But there is MUCH more to the story.

Mortgagebrokersbestoption

The fact is, there are many wholesale lenders and a mortgage broker selects a certain number with which to partner. While a mortgage broker may have access to many wholesale lenders, they will NEVER have complete representation.

Other mortgage brokers have their own best options

Each mortgage broker has an individual set of wholesale relationships. These relationships can be based on familiarity, proximity, or any other factor.

Additionally, each mortgage broker must be approved by a wholesale lender in order to offer their products and terms. Some wholesale lenders enforce minimum production requirements in order for mortgage brokers to remain “active” with them. Further, certain mortgage brokers can receive better/worse wholesale pricing based on a range of factors including quality of submissions and volume of transactions monthly/quarterly.

As a result of these factors, each mortgage broker will have access to a “best wholesale price.” Said another way, they will each have a different starting point with which to build their retail rate.

Otherbrokerswholesalelenders

Mortgage Broker 1 has presented the wholesale price that is lowest from his stable of options. Mortgage Broker 2 has access to a lower wholesale price. Mortgage Broker 3 has access to a less favorable wholesale price – the worst of the bunch.

If we assumed (wrongly, btw) that retail margins are all the same, then we see (below) how a wholesale price is related to a lower rate.  In these cases, the wholesale price is the main determinant of interest rate for the consumer.

wholesalewithretailmargin

When presented with these options, we should choose to work with Mortgage Broker 2.  Due to their exclusive access to the lowest wholesale price (amongst the three), they will provide the lowest interest rate.

A lower interest rate results in lower monthly mortgage payments – who wouldn’t want that?

Retail margins differ between mortgage brokers

Mortgage brokers generate revenue only when they produce loans. All expenses, such as loan officer commissions, office overhead, and marketing/advertising, are paid for from this transactional revenue. As a result, each mortgage broker requires a different retail margin to maintain profitability and the range can be significant.  

Operational overhead is one of the most common reasons why retail margins range. A mortgage broker with a large executive team (drawing hefty salaries) will result in the need for larger retail margins.

A mortgage broker paying a hefty monthly “marketing expense” to a real estate office can also be a contributing factor. These monthly fees, called MSAs, are masked from compliance regulators by associating them with “joint marketing activities.”  While the legality of them may be increasingly questionable, the funds required to repay this large expense increases the retail margins charged.

Applying the logic from above, let’s take a look at how our Mortgage Brokers made out in a competitive environment.

DifferentRetailMargins

Mortgage Broker 2 ends up being the worst choice for a mortgage borrower.  The large retail margin results in the highest interest rate compared to both other options.

Mortgage Broker 3 ends up with the lowest rate for a mortgage borrower.  Their low retail margin means they can provide the best interest rate, resulting in the lowest payment compared to the other two options.

Shopping between mortgage brokers is vital

According to the Freddie Mac April 2018 Insight, shopping just one additional source for a mortgage can result in savings approaching $2,000.  Shopping up to five sources can result in savings that approach $4,000.

While these numbers may seem significant, we see rates vary by as much as 0.50% between mortgage brokers. This difference presents a more significant opportunity than the Freddie Mac April Insight suggests.

Because mortgage brokers can’t represent every single wholesale option and inevitably have a differing retail margin, they can only partially act in the best interest of a customer.

Despite advances in technology and efficiency, mortgage shopping is a vital part of the mortgage process and should be done in each and every instance.

Compare HELOCs using a margin

Why margins matter in a HELOC

Let’s take a look at what a margin is and why margins matter in a HELOC (Home Equity Line of Credit).  For the purpose of this post on April 20th, 2018, we’ll be using the HELOC page found here.

HELOC margins range

What we see on the HELOC page is that margins can range quite a bit. In some cases, margins are as low as -1.25.  Other margins show as high as +1.00.  What does this mean when it comes to a HELOC and why is it important?

A real-world HELOC example

Let’s take a look at an analysis for a client that may be interested in obtaining a $100,000 line of credit.  Here it is:

 

In this particular analysis, we will be comparing a “High Margin” and “Lower Margin” line of credit.   In both cases, the Prime Rate is the same because it is not set by the bank.  The margin, on the other hand, is set by the bank offering the line of credit.  This is where you see a range of options.

The High Margin HELOC

The High Margin HELOC shows a margin of 0.50 percent.  When we add this number to the prime rate, we can see that our effective interest rate is 5.25%.  This interest rate will be charged until the prime rate moves up or down.  Any movement in the prime rate will simply move the Interest Rate by the same amount.

In this specific case, a client borrowing $100,000 at a 5.25% rate will need to pay $437.50 each month.

Lower Margin HELOC

When we compare the lower margin line of credit, with a margin of -1.25%, we see that the same client may end up paying just $291.67 per month.  This lower margin results in a savings of nearly $146.00 each month.

2018 Tax Rules may make this more important

Historically, any interest associated with a line of credit could be written off against income. Said another way, a homeowner who obtained a line of credit wasn’t “really” paying the interest rate they were given.  This is because they were able to deduct the interest payments from their earned income and receive a tax refund as a result.

The new tax laws starting in 2018 have changed the laws for HELOCs.  Now, there are many instances where the interest paid towards a HELOC may no longer be tax deductible. Due to this, it is more important than ever to consider savings that may be available from a HELOC with a lower margin.

HELOCs for Wealth Management Clients

Next, let’s examine a $250,000 Home Equity Line of Credit.

 

 

The same margins from above show that a savings of $364.58 is possible between a high margin HELOC and lower margin HELOC.

Cost and Shopping HELOCs

Home Equity Lines of Credit are easy to obtain and the costs to obtain them are either $0 or less than a few hundred dollars.  All else equal, it is important to understand how shopping the margins between HELOCs can have a substantial impact on monthly free cash flow.

If you’d like to evaluate lines of credit in the Philadelphia area, go here.

Mortgage Shopping Confidence from MortgageCS

Gain mortgage shopping confidence

Mortgages can seem complicated and intimidating, particularly in a world when we can “one click order” online.   How can you find out what you don’t know…but really should? How can you increase your mortgage shopping confidence?

When consumers shop for mostly anything, they evaluate the item or service they’re considering based on a predetermined set of criteria. Some considerations are easy, while others are more complicated. Mortgages tend to fall into the latter category. This is typically due to the intimidation factor and the perceived complexity of the product.

Mortgage loans come with an inherent, internal language the everyday consumer rarely encounters. If you wandered around a mortgage company, you’d hear phrases such as, “Where’s that VOD?” Not surprisingly, many of these phrases would be meaningless to you.

On the other hand, when someone decides they want to go out for a coffee, the choices are a bit more familiar sounding, and the decision most likely boils down to a matter of location and price. It’s pretty simple. While loan officers might wish the mortgage process were as easy as ordering a cup of coffee, it’s typically not.

Due to the varying factors of a mortgage transaction, borrowers should compare lenders based upon quoted interest rates and responsiveness, quality and trust. Consumers should approach mortgage education by explaining their needs and what they are looking to accomplish.

In this manner, they can find out more about the lender’s mortgage process and how loans are issued.

Finding a good mortgage loan officer

There is plenty of material online about how to shop around for the best deal on a mortgage. Certainly you want the best rate at the lowest cost, but you also need to consider the reputation of the companies you’re interviewing. But perhaps the process needs to be reversed.

When you call a loan officer and ask about a rate quote, the loan officer knows there’s competition.  He then provides the best available offering without considering all the details. The loan officer doesn’t have any reason to thoroughly evaluate your situation, so he falls into an all-too-familiar trap.  He provides a quote to win your attention potentially resulting in a bait-and-switch.

Here’s the problem with that: The quote alone doesn’t help lift the veil off the mortgage process or account for long term needs. It won’t ensure consumers make the right loan choice.  It won’t ensure that you come away from the closing with a clear understanding of what’s just happened and why. Yikes!

How can you, as a consumer, know what to ask to gain mortgage shopping confidence?

The surest path to pure mortgage nirvana is by communicating openly with the loan officers to facilitate learning early. This will be the best way to increase your mortgage shopping confidence.

Instead of considering only the interest rates, you should include a description as to what you are looking for.  Here’s an example: “Here’s my situation. I want low monthly payments, but I also want to save on long-term interest. I’m retiring in about 15 years and I want to be mortgage free.”

With this information, the loan officers know to quote you a rate on a program that matches your goals.  Surprisingly, that doesn’t necessarily mean a 15-year fixed rate loan.

A loan officer could suggest a 20-year loan, and set up a payment schedule that allows you to prepay just a little bit each month.  This would give you the security of a lower payment if ever needed. The extra payment would be applied directly toward the loan balance and would not go to interest.

Did you even know a 20-year loan was an option? Probably not, because most information you read is about either 30- or 15-year fixed rate loans. Instead of asking for a 15-year fixed rate and the associated fees, try explaining your current situation and what you want to accomplish.

Experienced loan officers know to include this information automatically, but unfortunately most get into a rate-and-fee game, leaving borrowers confused.

Another mortgage shopping example

“I need a quote for a duplex I’m thinking of buying.”

The loan officer answers and even sends a cost estimate showing how much down payment you will need, along with a list of anticipated closing costs. You get your quote, hang up and dial another mortgage company. Doesn’t that sound like fun? NOT!

Instead, how about saying: “I’m going to buy a duplex and live in one of the units. The current rent for each unit is $1,500 per month. I want the rental income to cover my mortgage, property taxes and insurance plus a little extra cash each month.”

Now, that’s a plan. Your loan officer will explain your options and what your monthly payments will be. He’ll also help structure a prepayment plan to retire the mortgage sooner, saving you long-term interest.

The loan officer in the second scenario will explain why each option is offered and how it meets your requirements. You may not have known how much your payments would be or whether the rental income could cover your mortgage payments.

You also may not have known your interest rate would be better because you plan to live in the property rather than renting it. By the end of the conversation, you’ll know how mortgages work and how they can be crafted around your exact situation.

Mortgage Shopping Confidence

By communicating your goals along with your rate request you’ll WIN at this process we refer to as the mortgage maze. You’ll also end up comfortable with the loan program you’ve selected. Now THAT is a WIN because you’ll increase your mortgage shopping confidence!

 

3 ways to keep your payment the same when rates are on the rise

When it comes to mortgages and the home buying process, interest rates are almost always front and center. This is not a surprising thing, as nothing else impacts the housing market quite like a quick rise (or drop) in mortgage interest rates.  Additionally, mortgage interest rates are one of the most commonly compared terms when consumers shop lenders and loan officers.

For most first time buyers, sticking to a budget is essential. So what is one to do when rates suddenly increase?  Well, there are a few options – some a bit easier to consider than the others.

Look for smaller homes in the same area

If your heart is set on purchasing a home in a particular area, interest rates have recently increased AND you are on a fixed budget, there is little you can do but search for a lower priced home. If you were looking for a townhouse, this may mean you need to reduce the bedroom and bathroom count or perhaps even switch to consider condominium units. You may no longer be able to afford a home with the upgrades you hoped to include or perhaps you can no longer afford the unit with a basement or garage.  In either case, some level of sacrifice will need to be made as the macro-environment of interest rates increases.

Look for homes in a less expensive area

Maybe your heart isn’t set on buying a home in a particular area – but rather the home’s amenities are front and center. If this sounds like you, then it may be easy to consider a home in a different school district, township or even over state lines (if applicable). Keep in mind that the school district can be a very important factor in reselling a property – so a bargain price today may be more difficult to sell in the future (and may appreciate at a slower rate overall).

Delay buying until next year

No real estate professional wants to see you delay the purchase of a home – and perhaps you don’t want to either. However, if you are set on a certain property type and location for your new home, this may be the most viable option provided that you can save money at a rate that will outpace the appreciation on the home and any subsequent increases in interest rates. Note: This may be a HUGE amount and ultimately be unknown until a time in the future. 

Keep in mind there are some significant risks with delaying the purchase of a home. First, the interest rate environment is largely unpredictable and rates could increase further – actually making the home less affordable next year.  Second, home prices could increase which translates to you spending more over the life of your loan, and missing out on a year’s worth of home value appreciation. Third, there is no way to know what the home inventory may look like.  If there are homes you would consider purchasing today, there is no way to guarantee the inventory will be available next year (Just ask anyone that wanted to buy a house in 2016 and waited until 2017 when inventories were down 40%!).