How Can I Avoid Being Overcharged?
April 19, 2000
"I have been advised by one friend to get my loan from a mortgage broker because brokers shop a lot of lender for the best deals, but another friend says it is too risky, that a lot of borrowers are overcharged by mortgage brokers. Who's right?"
They are both right. The trick is to take advantage of the superior service offered by mortgage brokers in scouring the market on your behalf, while protecting yourself against being overcharged. This column will tell you how to protect yourself.
Mortgage brokers are independent contractors who are free to charge whatever they wish for their services. When a problem arises, it is often because the borrower doesn't realize how much he is paying the mortgage broker until they get to the closing table.
Mortgage brokers make their money by adding a markup to the price quoted by the lender. For example, the "wholesale" price on a particular program might be 7% and 0 points, to which the broker adds a markup of 1 point, resulting in a "retail" price to the customer of 7% and 1 point. (1 point is an amount equal to 1% of the loan amount). But if the broker adds a 2 point markup, the customer would pay 7% and 2 points.
In general, mortgage brokers set the largest markup they can get away with in each deal. An unsophisticated customer who shows no inclination to shop the competition will be charged more than a sophisticated customer who makes clear an intention to shop. The largest markups are earned on unsophisticated customers who will accept relatively high interest rates. Wholesale lenders will usually offer brokers a side payment, called a "yield spread premium" for high-rate loans.
There are two way to protect yourself against being overcharged. One way is to shop multiple sources. This is the method proposed in Protecting Against Mortgage Broker Tricks. The problem is that shopping is both difficult and time-consuming.
The second approach is to hire a mortgage broker to shop for you, charging a fee specified in advance. This obliges the mortgage broker to do what every other tradesman does -- set the price for the service in advance. The price should be specified in dollars rather than as a percent of the loan, since the mortgage broker has to do as much work to deliver a small loan as a large loan. The following will do the trick:
I [Mortgage Broker] herewith agree that the total compensation for my services in obtaining a mortgage for John Doe, including all amounts paid me by Doe and by the lender who provides the loan to Doe, will be $X. If the lender pays me more than $X for the loan, the difference will be used to reduce Doe's other settlement costs.
What is a reasonable charge for a mortgage broker's services? I would expect to pay about $1,500, but I am an easy case for a broker because my credit is perfect, I qualify easily and I know just what I want. As a case increases in complexity and its demands on the mortgage broker's time, you should expect to pay more. I have seen cases where a mortgage broker worked with a customer over a number of months to raise the customer's credit score, resulting in a significant interest rate reduction. In a case of this sort, you should expect the fee to be closer to $4,000 than to $1,500.
October 12, 2001 Postscript: Since writing this, the procedure described above has grown into the Upfront Mortgage Broker concept.
"I have been advised by one friend to get my loan from a mortgage broker because brokers shop a lot of lender for the best deals, but another friend says it is too risky, that a lot of borrowers are overcharged by mortgage brokers. Who's right?"
They are both right. The trick is to take advantage of the superior service offered by mortgage brokers in scouring the market on your behalf, while protecting yourself against being overcharged. This column will tell you how to protect yourself.
Mortgage brokers are independent contractors who are free to charge whatever they wish for their services. When a problem arises, it is often because the borrower doesn't realize how much he is paying the mortgage broker until they get to the closing table.
Mortgage brokers make their money by adding a markup to the price quoted by the lender. For example, the "wholesale" price on a particular program might be 7% and 0 points, to which the broker adds a markup of 1 point, resulting in a "retail" price to the customer of 7% and 1 point. (1 point is an amount equal to 1% of the loan amount). But if the broker adds a 2 point markup, the customer would pay 7% and 2 points.
In general, mortgage brokers set the largest markup they can get away with in each deal. An unsophisticated customer who shows no inclination to shop the competition will be charged more than a sophisticated customer who makes clear an intention to shop. The largest markups are earned on unsophisticated customers who will accept relatively high interest rates. Wholesale lenders will usually offer brokers a side payment, called a "yield spread premium" for high-rate loans.
There are two way to protect yourself against being overcharged. One way is to shop multiple sources. This is the method proposed in Protecting Against Mortgage Broker Tricks. The problem is that shopping is both difficult and time-consuming.
The second approach is to hire a mortgage broker to shop for you, charging a fee specified in advance. This obliges the mortgage broker to do what every other tradesman does -- set the price for the service in advance. The price should be specified in dollars rather than as a percent of the loan, since the mortgage broker has to do as much work to deliver a small loan as a large loan. The following will do the trick:
I [Mortgage Broker] herewith agree that the total compensation for my services in obtaining a mortgage for John Doe, including all amounts paid me by Doe and by the lender who provides the loan to Doe, will be $X. If the lender pays me more than $X for the loan, the difference will be used to reduce Doe's other settlement costs.
What is a reasonable charge for a mortgage broker's services? I would expect to pay about $1,500, but I am an easy case for a broker because my credit is perfect, I qualify easily and I know just what I want. As a case increases in complexity and its demands on the mortgage broker's time, you should expect to pay more. I have seen cases where a mortgage broker worked with a customer over a number of months to raise the customer's credit score, resulting in a significant interest rate reduction. In a case of this sort, you should expect the fee to be closer to $4,000 than to $1,500.
October 12, 2001 Postscript: Since writing this, the procedure described above has grown into the Upfront Mortgage Broker concept.