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February 7, 2005
"In my market search I have come across
Discount Brokers, who seem to uphold many of the same ethical standards as
Upfront Mortgage Brokers (UMBs), but do not charge any fees for their service -
they claim they are compensated by the lenders. Isn�t that even better?"
Do Discount
Mortgage Brokers Charge Less?
The term "discount broker" implies that the
broker is providing services at a bargain price. Nothing could be further from
the truth. If they were practicing full and candid disclosure, here is what they
would say to you:
"You are paying me in the interest rate,
which is higher than it would be otherwise. I prefer to charge you this way
because I fear you will resist paying out of pocket and will haggle about the
amount. By charging you in the rate, payment is spread out over time in the
form of a higher monthly mortgage payment. This will upset you less than a
cash payment, especially since you are unlikely even to be aware of how much
higher the mortgage payment is. This is really win-win, since I get to charge
you more and my fee upsets you less."
The Different
Ways Borrowers Pay Mortgage Brokers
Borrowers and only borrowers pay mortgage
broker fees. However, payment can be made in two ways. One way is to pay the
broker in cash at closing, in which case the broker fee becomes a closing cost
to the borrower.
The second way is to pay a premium interest
rate to the lender, who pays the broker�s fee at closing as a quid pro quo for
the higher rate. In this case, the broker�s fee is not a closing cost to
the borrower. Rather, the borrower pays for it every month as an increment to
the mortgage payment.
Here is an illustration. On a 30-year fixed
rate mortgage, the lender quotes a rate of 6% at zero points, 5.75% at 2.5
points, and 6.25% at - 2 points. The lender will pay 2 points for a 6.25%
rate, a payment referred to in the trade as a "rebate" or "yield spread
premium".
If the borrower agrees to the
6.25% rate and the broker receives the rebate as his compensation, the broker
typically tells the borrower that "my fee is being paid by the lender". But this
is true only in the most superficial sense. The lender pays the rebate in order
to get the higher interest rate, and the borrower pays the higher rate. The 2
points paid by the lender to the broker is the present value of the higher
payments the borrowers will be making in the future.
Why Mortgage
Brokers Prefer Being Paid by Lenders
Bottom line, the borrower pays the broker fee
one way or the other. But many borrowers do not understand how the process
works, and are much more focused on the cash required to close than on future
payments. Further, the amount of any rebate paid to the broker is not readily
apparent on required disclosure forms. The borrower knows what the broker fee is
when he pays it out of his pocket, but may have little idea of what it is when
he pays for it in the rate.
The result is that borrower
resistance to broker fees is much weaker when the fees appear to be paid by the
lender. And increasingly, brokers seek their compensation entirely in this way.
The so-called "discount brokers" have merely formalized the process.
There is nothing wrong with a borrower
electing to pay the broker with a higher rate rather than cash, provided that
this is a deliberate selection. For a borrower with a short time horizon who
won�t be paying the high rate very long, paying with a higher rate makes sense.
On the other hand, a borrower who expects to have the mortgage a long time and
has the cash, does better using it to pay the broker.
If you are a shopper who intends to select a
loan provider based on price comparisons, the broker�s fee is irrelevant.
Neither does it matter whether a loan provider is a broker or a lender. You find
the loan provider who offers the best combination of rates and total fees,
period.
But if you are not up to price shopping,
which is extremely difficult to do effectively, and you prefer to retain a
broker to shop for you, then you should know what you are paying for this
service. Upfront Mortgage Brokers tell you, Discount Brokers don�t.
Copyright Jack Guttentag 2005
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