A mortgage broker connects a borrower with a lender. While that makes them middlemen, there are several reasons why you should consider working with a broker instead of going straight to a lender for your next mortgage.
For starters, brokers can shop dozens of lenders to get you the best pricing, says Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage” and mortgage advisor with C2 Financial Corp. in San Jose, California.
Fleming says the price he charges for certain lenders or banks is very often better than the price a consumer could get by going directly to the same lender.
“When the lender outsources the loan origination and sales function to a broker, they offer to pay us what they would otherwise pay to cover their internal operations for the same function,” Fleming says.
“If we are willing to work for less than that—and that is usually the case—then the consumer’s price through a broker ends up being less than if they went directly to the lender,” he explains.
Further, “A broker is legally required to disclose his compensation in writing — a banker is not,”says Joe Parsons, senior loan officer with PFS Funding in Dublin, California, and author of the “Mortgage Insider blog.”
Variety is another benefit of brokers. It can help you find the right lender.
“Some may specialize in particular property types that others avoid. Some may have more flexibility with credit scores or down payment amounts than others,” says David Reiss, a law professor who specializes in real estate and consumer financial services at Brooklyn Law School in New York and the editor of REFinBlog.com.
In addition, brokers offer one-stop shopping, saving borrowers time and headaches.
“If you are turned down by a bank, you’re done — you have to walk away and begin again,” Fleming says. But “If you are turned down by one lender through a broker, the broker can take your file to another lender,” he adds. The borrower doesn’t need to do any extra work.
A broker’s expertise and relationships can also simplify the process of getting a loan.
Brokers have access to private lenders who can meet with you and assess whether or not you have the collateral, says Mike Arman, a retired longtime mortgage broker in Oak Hill, Florida.
Private lenders, which include nonbank mortgage companies and individuals, can make loans to borrowers in unconventional situations that banks can’t or won’t because of Dodd-Frank regulations or internal policy.
You may get a better price on a loan from a broker as well.
Under the Consumer Financial Protection Bureau’s Loan Originator Compensation rule, brokers (but not bank lenders) must charge the same percentage on every deal, so they can’t raise their margin “just because” like a bank can, Fleming explains.
“The intent was to prevent originators from steering borrowers to high-cost loans in order to increase their commission,” Fleming notes.
You should also know that working with a broker won’t make your loan more expensive.
“The lender pays us, just like a cruise line pays a travel agent,” Fleming says.
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Mortgage broker vs. traditional bank lender
Banks issue less than half of mortgages these days, according to the industry publication Inside Mortgage Finance. But working with a broker isn’t necessarily a slam dunk.
“A broker may claim that he offers more choices than a banker because he works with many lenders,” Parsons says. “In reality, most lenders offer pricing on their loans that is very similar.” Although, he notes, a broker may have available some niche lenders for unusual circumstances.
Reiss says that even if you’re working with a mortgage broker, it can be worthwhile to check out lenders on your own since no broker can work with every lender — there are simply too many. He suggests starting with lenders you already have a relationship with, but also looking at ads and reaching out directly to big banks, small banks and credit unions in your community.
It’s important to know your range of options, he notes.
For the same reason, you might want to shop around with a few different brokers.
Arman says that Dodd-Frank rules make it “almost impossible to qualify for anything other than an absolutely plain vanilla loan” at a bank.
Loans that are guaranteed by the Federal Housing Administration or Veterans Administration, and loans that are sold to Fannie Mae or Freddie Mac, must meet strict requirements to prevent Uncle Sam from getting stiffed by bad loans.
According to Arman, you’re more likely to be turned down at the local back if:
- You have any title problems, credit problems or are self-employed.
- You are a foreign citizen.
- The house is the least bit unusual and doesn’t appraise high enough.
- You are half a percent off on your debt-to-income ratio.
- You have anything other than a completely conventional nuclear family.
- You have changed jobs recently.
- You have moved recently.
- You have applied for a credit card recently.
But Fleming points out that working with a bank can sometimes be faster than a broker. The loan processing and underwriting is usually done in-house and banks generally have fewer overlays (additional restrictions on lending guidelines). That means banks may be a little more likely to approve a loan that just barely meets guidelines, he says.
Banks usually sell the mortgages they issue to Fannie Mae or Freddie Mac after the loan closes. Fannie and Freddie have minimum requirements for borrower characteristics like credit score and debt-to-income ratio. If Fannie Mae says a borrower’s minimum credit score must be 620, a lender can choose a higher minimum, such as 680.
Also, unlike brokers, banks have flexibility on pricing, Fleming says. They can reduce their price if they have to compete. But that means they can also raise their price.
4 questions to ask a mortgage broker
Here are four questions to ask a mortgage broker whom you’re thinking of dealing with:
- Can I get references?
- How long have you been in business?
- How are you compensated?
- How do you handle rate locks?
Can I get references?
Ideally, you found the broker through a reference from a friend, relative or co-worker. But if you selected a broker through another criterion — maybe you drive past the broker’s office every day, or you responded to a direct-mail advertisement — you can request references.
Ask for the names and contact information for the most recent two or three customers who closed their loans. Then follow up by calling them. Ask if they were treated fairly and if the broker’s good faith estimate of closing costs was accurate. Above all, ask if they would do business with the broker again. You might find yourself talking to a borrower who already is a repeat customer — someone who got the original mortgage through the broker, then refinanced through the same broker. That’s a good sing.
How long have you been in business?
“I get asked that more than others,” says Ray Champion, president of Pro Mortgage Corp. in Dallas. “I guess people want someone who’s been doing it for a while.”
How long is long enough? Even a newbie to the mortgage business can give good service, but if you’re looking for someone who didn’t jump in to surf the current refinancing wave — in other words, someone who had a career in the mortgage industry in slow times as well as in today’s frenzied times — choose a broker who has been doing home loans for at least three years. Preferably more.
Thousands of mortgage brokers have jumped into the business since the refinancing boom began in early 2001. Many of them won’t be around when the refi boom ends. Your broker is more likely to stick around if he or she was brokering home loans back in the relatively lethargic days of 1999 and 2000.
How are you compensated?
Mortgage brokers get paid two main ways: fees and yield spread premiums. The broker’s fee often comes in the form of points, in which one point equals 1 percent of the loan amount. On the loan documents, you might find it listed as the lender’s origination fee or mortgage broker commission. You also might find application, funding, processing, document preparation and other fees.
The yield spread premium is a controversial way to compensate brokers. Here’s how it works: Let’s say you qualify for a loan at 6 percent interest. The broker persuades you to take a loan at 7.5 percent. The lender pays the broker several thousand dollars for signing you up for the higher-rate loan. That payment is a yield spread premium.
Theoretically, yield spread premiums aren’t necessarily harmful to borrowers. If you don’t have the money to pay closing costs, the broker can get you a loan at a slightly higher rate and apply the yield spread premium toward closing costs. Banks do the same sort of thing — underwrite no-cost loans for slightly higher rates than borrowers otherwise would qualify to pay.
A study published in 2002 by Harvard Law professor Howell E. Jackson concluded that yield spread premiums “are not a good deal for borrowers, but serve primarily to increase compensation paid to mortgage brokers.” Jackson conducted his research while preparing to serve as an expert witness on behalf of borrowers who were suing a bank that gave yield spread premiums to brokers.
When you get your good-faith estimate of closing costs, and later when you get your HUD-1 statement of final closing costs, scrutinize the items in the 800 section, near the top of Page 1. Ask the broker to explain the numbers. Any yield spread premium should be listed there, possibly with the notation that it’s “paid outside of closing” or “POC.”
How do you handle rate locks?
Some brokers gamble with rate locks. You tell the broker to lock a certain rate on a certain date, and the broker tells you over the phone that your rate is locked. Secretly, the broker doesn’t lock the rate, hoping that rates will drop before your closing day.
If rates drop — even if they dip for just a day — the broker can lock at that lower rate. You pay the higher rate that you locked at. The broker can make a little profit on the difference.
If rates don’t drop, and instead they rise, the broker might tell you that there was a glitch in your paperwork, or that the loan process was otherwise delayed, and that it’s impossible to close your loan before your rate lock expires. Or the broker might tell you that you are mistaken, and that you never really did lock your rate.
The safest way to go is to ask your broker for a loan commitment letter from the lender. It should have the lender’s name and specify the interest rate, the date the rate was locked, and when the lock expires.
The bottom line
As with any product or service, shopping around for a mortgage is always a good idea. Whether you decide to go with a bank or mortgage broker depends on your financial situation and personal preference.
Remember, before committing to a loan with a banker or a broker, make sure to get an itemized estimate of fees.