There are many mortgage professionals who are skilled, honest and dedicated to their customers. But if you're shopping for a mortgage, those aren't the ones you need to worry about.
In my last column, I highlighted mortgage conflicts in the banking world. This time I'll reveal potential pitfalls when dealing with less-than-ethical independent mortgage brokers.
One of the biggest challenges some brokers face is the lure of letting compensation dictate their recommendations. Brokers are usually paid by the lender for referring customers and processing applications. But that compensation varies, with some lenders and mortgage types paying more than others. For a minority of brokers, the prospect of a higher payday is irresistible.
Generally, the longer the mortgage term, the more a broker gets paid. One-year terms, for example, pay 25 to 50 per cent less than five-year terms. An unethical broker may consider that a disincentive and rarely sell a one-year term, even if it's the best fit for a client.
This, of course, sparks concerns about how often unsuitable mortgages are recommended. It's one example of why forward-thinking regulators in Ontario, Saskatchewan and Nova Scotia require that brokers confirm suitability when recommending a mortgage. This suitability legislation, which doesn't apply to mortgage salespeople at banks, is a consumer protection that should be adopted in every province of the country.
Some of the term bias in the mortgage business stems from inexperience. A newbie broker may not know how to weigh the risk or reward of a one – or 10-year term with the needs of a client. Instead, they may simply recommend a "safe" garden variety five-year fixed.
How much experience do brokers need to be competent? "If they're brand new to the industry with no lending experience, it can take up to five years to learn the permutations [of the mortgage market], understand credit and apply it relevantly," says Rob Regan-Pollock, a senior mortgage adviser and veteran broker with Invis.
One of the biggest conflicts of interest in the broker world is something called "scaled pricing." That's where a lender offers two rates for the same mortgage: a competitive rate with fair compensation to the broker, and a higher less-competitive rate which pays the broker extra.
Some brokers sell those above-market rates and the client is none the wiser. In certain cases, it may be justified if the borrower has qualification challenges that demand an unusual amount of effort or expertise. But a less-fiduciary broker may simply pocket the extra commission.
How do you as a customer prevent this from happening?
Step one is asking this question point blank: "Is the rate you're quoting me the lowest rate for that term on that lender's broker rate sheet?" If you have any doubt, ask another broker for a second opinion.
Step two is knowing the most competitive rates in the market. Compare a broker's rates against those you find online. Just make sure that the rates you've found include similar privileges, the same or fewer restrictions, comparable service/advice, like qualifications and the same rate guarantee period. If a broker then tries to sell you a materially higher rate – e.g., 3.14 per cent instead of 2.99 per cent – he or she better have a good reason.
Another broker conflict is what's known as status programs. That's where a lender gives a broker better rates and service in return for higher volume.
On one hand, this is great for customers because they get that lender's best deals and fast turnaround. High-volume brokers who are loyal to a lender also tend to know that lender's products inside out, minimizing surprises on or after your closing date.
However, when a broker sends a mortgage to a lender primarily to meet its volume targets, status programs become a problem. Some brokers do this to maintain their perks with a lender, even though another lender has a better mortgage for that client.
Data from mortgage technology provider Davis + Henderson suggests there are 24 lenders that do significant business with brokers (i.e., control more than 0.1 per cent of the broker market). Theoretically, that lets brokers offer far more choices than the one option people get when they go to a bank.
Yet, according to Maritz Research, a whopping 90 per cent of the average broker's volume goes to only three lenders. Those three lenders may have the best rates and products for the broker's target clientele – or they may not.
At any given time, only one of those 24 lenders may have the optimal mortgage for a given borrower. But, if you're a broker who only uses a handful of lenders, your customers' chances of getting that best deal drop considerably. That's why dealing with a high-volume broker can pay.
"There is power in volume," says Mr. Regan-Pollock. "Lender status matters and that's something that consumers don't really know."
If a brokerage closes $200-million versus $20-million, for example, "That gives it more options for best pricing. If I can get a nickel or dime (0.05 per cent or 0.10 per cent) off the rate, that is significant savings over five years."
When you're shopping for a broker, a $100-million-plus broker team will generally provide you the widest array of rates and options. It's a sad truth but mom and pop independent brokers are a dying breed in the mortgage broker business.
Rates rates rates
If you talk to a broker you've never met and the first thing out of his or her mouth is a rate quote, you may have picked the wrong broker.
"Mortgage professionals don't get into rates without explaining products," says Mr. Regan-Pollock. "It's a warning sign when someone talks about the rate before they know who I am and have a strategy session."
The reason? Rates are just one part of total borrowing cost, which can rise due to things like: fees, penalty calculations, prepayment restrictions, completely closed terms, portability restrictions and uncompetitive rates when adding money to your existing mortgage or converting to a different term.
When a broker quotes rates without knowing a client's circumstances, they become a glorified "shopping service," says Mr. Regan-Pollock, as opposed to a trusted adviser who recommends a mortgage relevant to your future plans.
Conflicts, like those above, are supposed to appear in disclosure documents mandated by provincial regulators. But I've seen cases where the disclosure language is so vague, the clients would have little clue they've been sold an inferior mortgage.
It's important to stress that most brokers, like most bank mortgage representatives, truly do have their client's best interest in mind. After all, we're in a business that lives off referrals. But you have to keep vigilant and never be afraid to challenge your mortgage adviser with hard questions.
Here are five such questions to remember:
1. How long have you been in the business? (Ideally, at least two to five years)
2. How many lenders does your team have "top-tier status" with? (Preferably six to seven or more)
3. Is the rate you're quoting me the lowest rate for that term on that lender's broker rate sheet? (If not, why not?)
4. How much volume did your team do last year? (Ideally $100-million-plus)
5. Do you do over 50 per cent of your business with one lender? (If so, why?)