Did the Broker Make More by Steering the Customer?

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September 4, 2006

"Does a mortgage broker make more money with an option ARM than with a fixed-rate mortgage? I went to the broker looking for a 30 year fixed deal and allowed them to talk me into an option ARM -- with a three year prepayment penalty that I didn’t find out about until the closing. I have perfect credit and didn’t need the lower payment, I have been making the fully amortizing payment every month. Did they steer me into that loan because they made more money on it?"

In all likelihood, yes. The price of a 30-year FRM is difficult to conceal, the borrower knows what the rate is and what it means. On an option ARM, the principal price is the margin, which most borrowers don’t understand and which is not a required disclosure.

The margin is the number that is added to the rate index every month, starting in month 2, to determine the new rate. Paradoxically, because margins don’t fluctuate with the market, option ARMs are the easiest type of mortgage to shop – if you know the secret, which is to shop the margin.

But if you don’t know that secret, and if you place yourself in the hands of a loan provider intent on making as much as possible from the deal, the option ARM is the perfect vehicle for such skullduggery.

For example, assume a competitive margin in your case was 2%. If the broker raised it to 3%, without any discussion with you, the price paid by the lender would rise by about 2.5 points. That’s 2.5% of the loan amount, and it would all go in the broker’s pocket.

Unless, of course, you were dealing with an Upfront Mortgage Broker (UMB), or a broker who adhered to upfront principles. In that case, you and the broker would have agreed on the broker compensation before selecting a loan type, and there would be no reason for the broker to steer you to an inappropriate loan. In the unlikely event that you decided you wanted an option ARM and were willing to pay the higher margin, the 2.5 points would have gone in your pocket rather than the broker’s.