Am I Unfair to Mortgage Brokers?
July 23, 2001
Ever since I began warning consumers about tricks of the mortgage broker trade, I have been fielding angry letters from brokers. Some of them are fit to print, and even thoughtful. It is time to deal with their arguments.
"Why do you write as if brokers are the only ones who play games with borrowers? Don’t lenders’ loan officers play the same games? Why don’t you write about them?"
I have no reason to believe that loan officers employed by lenders are more scrupulous than brokers. In fact, many brokers learned their trade (and their tricks) when they worked for lenders.
One reason I focus on brokers is that 7 out of 10 borrowers get their loans through brokers. But the major reason is that I believe that brokers ought to be held to a higher standard of service than lenders.
Lenders provide money and service, but brokers only provide service. Their sole reason for being is that their service is better than that of lenders. If that is not the case, there is no reason for brokers to exist.
Recently, I proposed that brokers who accepted that responsibility operate explicitly as agents of borrowers in finding mortgages. They should establish an upfront fee for their services in writing, and disclose and pass through wholesale prices from mortgage lenders. I have even proposed that brokers be required by law to operate in this way.
In contrast, the great majority of mortgage brokers operate as independent contractors, concealing lender prices (and the brokers’ markups on those prices) as long as possible. This way of doing business mucks up the distinction between brokers and lenders. It also creates a conflict between the interest of the borrower and that of the broker. The more the broker can induce the borrower to pay, the more the broker makes.
“Consumers can buy groceries or appliances quite well without knowing how much the merchant’s markup is. Why is a mortgage any different?”
Groceries and appliances are very easy to shop. When consumers make mistakes, losses are small and they correct them next time around. Most consumers don’t need any help.
Mortgages, in contrast, are extremely difficult to shop, even for sophisticated consumers. The losses from making a mistake, furthermore, are enormous. Most borrowers want professional guidance from an expert.
Borrowers should be able to retain experts whose financial interests are not in conflict with their own. Eliminating conflict means passing through the lenders’ prices and setting a separate price for the professional’s services. As with any professional service they purchase, consumers have a right to know the price in advance.
“It is blatantly unfair to require brokers but not lenders to reveal their markups. Either they both should be required to disclose, or neither should. Don’t you believe in a level playing field?”
Disclosure of markups reduces the capacity to deceive borrowers. Hence, this question can be rephrased as follows: “Shouldn’t brokers have the same opportunities as lenders to deceive borrowers?” No, they should not.
Lenders sell loans, and I expect them to try and get the best price possible, like any other seller. Brokers sell service, and a critical part of their service should be to protect the borrower from the lender. Brokers have the right to charge whatever they can induce borrowers to pay for their service. However, they should do it in the light of day rather than conceal it in the markup.
“I don’t have any issue with mortgage brokers who want to operate strictly as service providers, so why do you have an issue with brokers who want to operate as independent contractors? Why not let them both operate and let the market decide?”
You would have a good point if borrowers could distinguish the two so they could make an informed choice. Under existing circumstances, they can’t. But I would buy into a system where states offered two kinds of broker licenses and required brokers to identify themselves prominently as either independent contractors or borrowers’ agents. Would you?
Postscript of October 15, 2001
My statement that brokers ought to be held to a higher standard than lenders was a bit cavalier because there is a major category of lenders who operate in exactly the same way as brokers except that they have the capacity to close loans in their own name. Such lenders take no market risk because they operate against price commitments from lenders, just as brokers do. They should be subject to the same rules as brokers. This is discussed in HUD and Yield Spread Premiums.
Ever since I began warning consumers about tricks of the mortgage broker trade, I have been fielding angry letters from brokers. Some of them are fit to print, and even thoughtful. It is time to deal with their arguments.
"Why do you write as if brokers are the only ones who play games with borrowers? Don’t lenders’ loan officers play the same games? Why don’t you write about them?"
I have no reason to believe that loan officers employed by lenders are more scrupulous than brokers. In fact, many brokers learned their trade (and their tricks) when they worked for lenders.
One reason I focus on brokers is that 7 out of 10 borrowers get their loans through brokers. But the major reason is that I believe that brokers ought to be held to a higher standard of service than lenders.
Lenders provide money and service, but brokers only provide service. Their sole reason for being is that their service is better than that of lenders. If that is not the case, there is no reason for brokers to exist.
Recently, I proposed that brokers who accepted that responsibility operate explicitly as agents of borrowers in finding mortgages. They should establish an upfront fee for their services in writing, and disclose and pass through wholesale prices from mortgage lenders. I have even proposed that brokers be required by law to operate in this way.
In contrast, the great majority of mortgage brokers operate as independent contractors, concealing lender prices (and the brokers’ markups on those prices) as long as possible. This way of doing business mucks up the distinction between brokers and lenders. It also creates a conflict between the interest of the borrower and that of the broker. The more the broker can induce the borrower to pay, the more the broker makes.
“Consumers can buy groceries or appliances quite well without knowing how much the merchant’s markup is. Why is a mortgage any different?”
Groceries and appliances are very easy to shop. When consumers make mistakes, losses are small and they correct them next time around. Most consumers don’t need any help.
Mortgages, in contrast, are extremely difficult to shop, even for sophisticated consumers. The losses from making a mistake, furthermore, are enormous. Most borrowers want professional guidance from an expert.
Borrowers should be able to retain experts whose financial interests are not in conflict with their own. Eliminating conflict means passing through the lenders’ prices and setting a separate price for the professional’s services. As with any professional service they purchase, consumers have a right to know the price in advance.
“It is blatantly unfair to require brokers but not lenders to reveal their markups. Either they both should be required to disclose, or neither should. Don’t you believe in a level playing field?”
Disclosure of markups reduces the capacity to deceive borrowers. Hence, this question can be rephrased as follows: “Shouldn’t brokers have the same opportunities as lenders to deceive borrowers?” No, they should not.
Lenders sell loans, and I expect them to try and get the best price possible, like any other seller. Brokers sell service, and a critical part of their service should be to protect the borrower from the lender. Brokers have the right to charge whatever they can induce borrowers to pay for their service. However, they should do it in the light of day rather than conceal it in the markup.
“I don’t have any issue with mortgage brokers who want to operate strictly as service providers, so why do you have an issue with brokers who want to operate as independent contractors? Why not let them both operate and let the market decide?”
You would have a good point if borrowers could distinguish the two so they could make an informed choice. Under existing circumstances, they can’t. But I would buy into a system where states offered two kinds of broker licenses and required brokers to identify themselves prominently as either independent contractors or borrowers’ agents. Would you?
Postscript of October 15, 2001
My statement that brokers ought to be held to a higher standard than lenders was a bit cavalier because there is a major category of lenders who operate in exactly the same way as brokers except that they have the capacity to close loans in their own name. Such lenders take no market risk because they operate against price commitments from lenders, just as brokers do. They should be subject to the same rules as brokers. This is discussed in HUD and Yield Spread Premiums.