Decoding Mortgage Broker Compensation
According to a recent CMHC survey, 80% of first-time buyers plan to consult with a mortgage broker. Often a mortgage broker (“broker”) will say there is no charge for their help in finding a good mortgage and negotiating mortgage terms with the lender. This isn’t entirely true! Here are some direct quotes from brokers websites:
Let’s revisit the last line, “lenders pay us to process your mortgage on their behalf.” That means that, to some degree, the mortgage broker is really working for the lender and not you. You need to know that lenders have structured the fees to mortgage brokers in a way that provides the brokers an incentive to:
Be loyal to one lender
Not discount the 5-year mortgage interest rate
It makes perfect sense; they want to reward people who send them lots of business and if the broker does things that cost the lender money then the lender wants the broker to share some of the cost.
Since brokers, DON’T WORK FOR FREE should you be concerned about who is paying them and how? As a borrower, does your broker have any incentive to betray your trust? This article will explore the qualities you should look for in a broker, broker compensation, the resulting incentives, and the potential issues you should know about.
Before diving into the details, let’s recognize that the vast majority of brokers are ethical and honest. The purpose of this article is simply to help you understand the factors at play.
Why do people choose mortgage brokers?
Buying a home is typically the biggest financial commitment you will make in your life and you need to feel confident in your decision. Mortgage brokers are a valuable resource to help Canadians get access to a variety of traditional lenders and innovative lenders. Some of these lenders are exclusive to brokers: instead of spending millions buying up real estate for branches and staff instead they offer their mortgages exclusively through brokers.
Mortgage Brokers are provincially licensed and regulated and are expected to meet high ethical standards.
Just keep in mind that mortgages have some critical product features other than rate, and also that lenders advertise low rates a part of a marketing campaign which may not be available to you or that the lender consistently provides low rates.
To illustrate the complexity of mortgage products, we counted 25 different rates for a 5 year closed term with a single lender. That is why Mortgage Sandbox recommends that you work with a mortgage broker.
How mortgage brokers are paid
Brokers make money in two primary ways:
1. A finder fee is paid by the lender
2. The broker charges a fee to the borrower
1. Lender Paid Finder Fee
Finder fees vary depending on the duration of the mortgage contract.
If you commit to 5 years with the lender, the mortgage broker would be paid between 0.75% and 1.00% depending on the lender and the type of mortgage. If you commit to two years, the broker will be paid between 0.45 and 0.75%. Using the 5 year contract on a $300,000 mortgage, the broker would be paid $2,250 to $3,000.
On a 5-year fixed mortgage, some lenders allow brokers to “buy down” the interest rate by up to 0.10% by giving up some of their fee. In our example, the broker would have to trade $900 to $1,200 of their finders fee to get the borrower 0.10% off of the 5-year fixed mortgage rate. Essentially, they would lose 40% of their income to get you an extra 0.10%.
Since finders fees are fairly standardized, lenders have tried to make themselves more attractive to brokers by offering volume bonuses and other perks to reward brokers for funneling more business to them.
Lenders also penalize brokers who have a low funding rate (i.e., they got an approval but failed to fund the mortgage) by no longer looking at their deals or reducing finders fees. They do this because reviewing and approving a mortgage costs the lender time and money. Keep this in mind when you ask a broker to approve a mortgage for you. They will be penalized if you take your business elsewhere whereas branch staff at a bank or credit union won’t be penalized in the same way.
2. Borrower Paid Broker Fee
Only “Prime Lenders” and some “Alternate Lenders” pay finders fees. Private lenders don’t pay the broker a fee so the broker needs to charge a fee to cover their time invested in finding you financing.
In this case, a broker can negotiate the fee with you and can then act as an advocate on your behalf. This fee structure has the least potential for conflict of interest but the fee is paid by the borrower and not the lender.
For a typical private deal a broker will charge 1% of the value of the mortgage. If your deal is a difficult one, then they may ask for 2% or more. If they don’t find you financing they are paid nothing. Keep in mind that if you sign an agreement and they find you a good deal then you are on the hook to pay their fee. Looking at the $300,000 mortgage, the borrower pays the broker $3,000.
Let’s do the math to figure out a broker’s revenue. A Vancouver household with the median income can only qualify for a $300,000 mortgage. If a broker gets a full finders fee, then they will have to complete 20 mortgages annually to gross $60,000 annually. To complete that many mortgages, they will need to start applications with 100 applicants per year. Why so many? Well, some are already approved elsewhere and are simply rate shopping (time wasted for the broker), others are looking to transfer at renewal time but then decide switching isn't worth the legal fees and trouble, still others would love to work with the broker but can’t buy at current home prices.
You may not realize that brokers can also be penalized by the lender. If a broker has a low completion rate then they may not qualify for volume bonuses. This means if the broker gets an approval from the lender but doesn’t follow through it will count against them. This is one reason brokers don’t send deals to 10 lenders and pick the best one. Instead they pre-screen the deal and identify the best lender for that borrower. They then send the deal to the best suited lender.
Why brokers tend not to operate independently
Since lenders offer bonuses and perks for high volumes and will sometimes cut off brokers who do not send them enough business, brokers pool their business. In effect, a group of brokers will run all of their deals for Lender A through one individual who will gain a high status with that lender, earn volume bonuses, and receive perks on behalf of the group. Obviously, this is “gaming” the system but lenders seem to encourage it. Perhaps because they take comfort that all deals are going through a gatekeeper who knows their rules and policies well? Or perhaps they started offering it to brokers and now they risk losing business if they try to stop the practice.
Critics of broker commissions tend to focus on the gross commission but that ignores significant broker expenses. Corporate and franchise brands (e.g., Dominion Lending, Mortgage Alliance, Verico) take a percentage of a broker’s gross revenue to cover their costs. They then use this money to invest in technology, sponsor the Home Show, run ads on TV (Dominion Lending has Don Cherry as their spokesperson), and rent out offices. They can charge brokers up to 25% of their finders fees to pay for all of this.
As well, there are individual expenses for driving to meetings with borrowers, other marketing, and promotional expenses, and sometimes gifts/fees paid to realtors or other professionals for referring customers to them. If we factor 25% expenses into the equation, a broker needs to fund a minimum of 27 mortgages annually to make $60k after expenses and before taxes. That’s a lot of hustle.
Regardless of the strength of a broker’s ethics, you need to be aware of the of how their financial incentives can influence them. Sometimes what is good for a broker is also good for the borrower, but sometimes it’s not.
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Sandbox Suggestion: Don’t get suckered with rate bait. Some lenders advertise enticingly low rates for which you are unlikely to qualify.
Broker incentives can lead to some unfortunate behaviours.
Focus on the 5-year rate
72% of home buyers take a fixed rate mortgage and most of them choose a 5-year fixed rate. Since home buyers tend to have this rationale, it is easier for a broker to continue to offer a fixed rate when it may not be the best option for a particular customer’s situation. Additionally, a mortgage broker will be paid a slightly higher finder's fee for a 5-year contract than a shorter one resulting in a general bias towards the 5 years fixed rate.
Order-taker rather than advice-provider
Many customers have researched mortgages and approach a broker with aggressive and inflexible interest rate demands. The broker may want to provide valuable advice but doesn’t want to be perceived as not cooperating with the customer’s request. In this case the broker may give the customer what they ask for whether it's in their best interest or not. They do this because they are afraid the customer will interpret the brokers questions as an unwillingness to give them what they want. We estimate there are potentially 90,000 different mortgage feature combinations which we explore in more detail in our mortgage basics. A mortgage broker can take the time to understand your priorities and find the right features for your personal situation. If they merely take your order it could be to your detriment because they can be a powerful advisor.
Turn a blind eye to misrepresentations
If you lie on your application for a mortgage, you may be able to qualify for more money or a lower rate. Although this may seem like a victimless crime, it is still fraud. After funding, if a lender suspects misrepresentations or forged documents in a mortgage application they can demand new documentation to confirm the fact, and if they discover fraud, they can press charges and demand repayment.
The jury is out on whether brokers who earn 100% commission income have a stronger incentive to turn a blind eye to misrepresentations than bank staff who have a salary with a bonus tied to sales targets. Brokers get a bigger incentive “carrot” for more sales but they can’t be fired. Bank staff who, when they don’t hit aggressive sales targets, may lose their jobs could have incentive to bend the rules. Mortgage broker ethical infractions are published by the provincial regulator while branch staff infractions are usually handled as an employee disciplinary issue and settled privately to protect the institution’s reputation.
There are rules against unethical behaviour and brokers can receive a written warning, a fine, or have their license revoked if they’re caught doing something unethical, but proof is often hard to establish.
Some people feel that brokers make too much money or the job is easy, but realistically very few brokers are getting rich. About 3,500 brokers in British Columbia sold approximately 60,000 mortgages in a year. That’s an average of 17 transactions per year which is below the threshold we calculated necessary to gross $60,000 in revenue. In truth, some brokers are talented and do well while others don’t make much money at all. It’s unfair to try to compare commission incomes or small business incomes to salaries.
To put the risk of this industry in perspective, on January 1st 2018 the federal government enacted new mortgage rules that will reduce the average mortgage size by 20%. That’s essentially a law that give mortgage brokers a 20% cut in pay from one year to the next!
Being an broker can be a very tough job. They may have to meet many hopeful home buyers with only a fraction turning into paying business. They work weekends and evenings and are generally on-call at all hours.
Mortgage Sandbox still feels that more could be done to protect consumers from unethical practices and we are developing an easy to use, data driven, matching tool that will connect Canadians with pre-screened, local, ethical real estate professionals, who share their interests and values, and have complimentary ways of working.
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1. CMHC Mortgage Consumer Survey 2018
2. AMP Annual State of Residential Mortgage Market, November 2017
3. Globe & Mail
4. 2016 CMHC figures ar 153,000 mortgages annually and according to AMP 39% are obtained through mortgage brokers.