Mortgage Brokers and the Three Axes

Susan E. Woodward and Robert E. Hall write,

Untrained, inexperienced borrowers interact with specialist mortgage brokers in the mortgage origination market. Brokers earn two kinds of compensation, explicit charges the borrower pays in cash and a commission the lender pays based on the spread between the coupon rate the borrower agrees to and the par mortgage interest rate. Both types of broker compensation seem to confuse borrowers. The wholesale lender’s commission is determined by financial dynamics understood by a tiny group of professionals, and the rate sheet that summarizes the possible payments is never shown to borrowers.

…With respect to policy changes that might help achieve a more efficient equilibrium, we believe in evidence-based design. Disclosure law has historically been in the hands of lawyers, who designed dense forms that may help absolve their clients of blame for consumer error, but which did little to help consumers find better deals. A new movement to design disclosures that are proven to be helpful, through field experiments, may result in some progress. Whether these forms can overwhelm the persuasion of skilled expert salesmen remains to be seen. We are inclined to believe that simple admonitions, such as “mortgage brokers are salesmen and the only way to get a good deal is to shop and bargain” and “you are more likely to get a good deal if you shop for no-cost loans” are more likely to yield improvements than, for example, trying to teach borrowers enough financial economics to understand the tradeoff between cash and the interest rate.

(Note that the quote is from the published version, which is subscriber-only. The link goes to an earlier version.)

This can be viewed through the oppressor-oppressed narrative. Mortgage brokers can earn more money by luring borrowers into more expensive mortgages (usually, “more expensive” means a present-value cost to the borrower of $1000 or so, but it can be higher than that). Note, however, that as Woodward and Hall point out, this does not make mortgage brokers rich. The brokers operate in a highly competitive environment, and while they over-charge as many borrowers as they can, profits are competed away in marketing expenses used to try to lure those borrowers.

This also can be viewed through the civilization-barbarism narrative. This sort of business does not exactly attract and reward caring, conscientious sorts of people. I think of mortgage brokers as slick and deceptive salesmen, prone to sports cars, bling, and other signs of conspicuous consumption.

Of course, from the standpoint of the freedom-coercion narrative, nobody forces you to take a loan from a mortgage broker, and it is a highly competitive industry. However, I think you have to be at least in the 99th percentile for sophistication in legal and financial calculations in order to be able, as a consumer, to use the competition to your advantage and to get the best possible deal.

I am pessimistic that consumer education or rules-based regulation can prevent consumers from being exploited in these situations. I think that the best chance is with principles-based regulation. That is, rather than designing the disclosure form, introduce the principle that disclosure should enable the consumer to understand and compare fees from different lenders.

8 thoughts on “Mortgage Brokers and the Three Axes

  1. I appreciate your three axes paradigm, but here’s another paradigm. Mortgage brokers frequently give you a better deal on the paper from any given bank, than the same bank would give the same customer walking through the banks own door and cutting out the broker as middleman. Yes, banks sell their paper way cheaper to the middleman, than to their own customers. My own broker sold me a Wells Fargo Loan for a quarter point less than Wells would sell it to me, and Wells wanted an origination, my broker did not. My broker said, that is a very common occurence.

    • Yes, this happened to me too. My broker got me a full 1/2 point less and no origination fee than wells Fargo wanted. It’s crazy that wells gives their brokers such good deals

  2. I would that simple heuristics would get more than 90 percent of the benefit the 99th percentile borrower would get.

    1. Go to a broker. Don’t respond to unsolicited junk mail.
    2. Get no-point, no-fee financing. Compare the rates with what you see on one of the many clearinghouse websites.
    3. You’ll still get dinged with a couple hundred dollars of something or other at closing. Don’t mind it.

    And Jardinero1 is right. A Chase refi of my Chase mortgage was half a point higher than a refi brokered out of some Florida bank that I found on the web that ended up being immediately turned over to… Chase.

    Nonetheless, when at a later time Chase sent a letter saying, effectively, they’ll do everything and I don’t have to do squat but accept the lower rate, I didn’t bother to compare with any more complex refi. They had learned something — even if it was to mine their own data to find people who will walk when rates drop so many percent.

  3. One thing to think about with respect to any “axis” (be there 3 or more than 3) is “how does this interact with the finite nature of humans? in particular their cognitive limits?”

    Another is “what is the big issue in this transaction?” – meaning, does the buyer actually care about anything at all other than (a) down payment (b) monthly payments in all circumstances, including much higher interest rates?

    How much money goes to orgination fees, commissions, spreads, etc. doesn’t really matter. What matters is $X total right now, $Y per month. Period. Whole discussion.

    Then public education could focus on “current interest rates are really really low so your $Y ARM probably will go up to ….” instead of trying to get everybody to grok NPV just long enough to evaluate 1 transaction.

  4. To echo what jardinero said, I bought a car this year and got a loan for half a point less from my bank, through him, than I got from my bank directly. I’ve been a customer for eight years so they certainly know me. It raises a good question of whether brokers really rip people off as much as seems to be assumed.

  5. just look at the APR and do 30 year fixed
    The rule is simple, and very similar to why l5 year level term premium is the best life insurance:
    if you are a CPA, or similarly talented, and have a lot of time, you can shop for the best mortgage.
    if you are a normal person, you don’t have the time and skills to evaluate diff types of mortgages (or the complexities of whole life insurance) so just go with something simple that you can understand; you may not get the best possible deal, but you will get a reasonable deal, and more importantly, you will avoid getting a bad deal
    that it, the upside between the best deal with the simple metric (lowest apr 30 year fixed) and the best possible is not htat great, while the down side is really big.