You already know that mortgage brokers come in many flavors, that some of them deserve the bad reputation dished out to them lately. You”re also smart enough to know that they serve a great function: getting you mortgages that your bank cannot.
To better understand how mortgage brokers are useful to you, you should know how they operate and get paid.
Mortgage Brokers in Action
When you get a home loan from your local bank, there may be only one player involved, your local bank. Banks that originate a home loan and hold on to it are called portfolio lenders. Many banks, however, do not hold onto the loans they originate. They sell the loans for a profit. They may sell your loan to another lender, directly, or they may sell it to a wholesale buyer.
In other words, many banks behave exactly like mortgage brokers.
The process goes like this:
You go to mortgage brokers to get a loan. The first thing they do once they have your credit scores, down payment (equity) and the amount you want to borrow is find out if Fannie Mae (Freddie Mac) will buy your loan and under what circumstances.
It’s all computerized. Your broker inputs your information in the system, the system comes back with: you qualify or you don’t qualify. Actually, it comes back with numbers, percentages: how much you can borrow and what interest rate you’re going to get and how much the broker is going to make.
How Mortgage Brokers Get Paid (Usually)
The interesting part comes here. Brokers are presented with 3 income levels for themselves. Which means: if they give you the lowest interest rate you qualify for, they make a low amount, if they give you a higher one, they make more money.
Specifically, it will come like this:
Interest rate of 5.04% – the broker earns 1.25% of the loan amount.
Interest rate of 5.15% – the broker earns 1.50% of the loan amount.
Interest rate of 5.30% – the broker earns 2.25% of the loan amount.
On a $200,000 home loan, this means your broker’s company can earn $2,500 or $3,000 or $4,500. Sometimes, overhead alone does not allow your broker to quote you the lowest interest rate you qualify for. Overhead makes many brokers turn away applicants who want to borrow small amounts.
Once brokers are assured that your home loan fits Fannie Mae criteria and you’ve accepted the interest rate, they will look for a wholesale buyer who can work with your particular circumstances.
The wholesale buyer who gets your home loan turns around and sells it to another wholesale outfit or to an investor (this could be a bank, a hedge fund, a pension fund, a private person or any company that has the money). I heard mortgage brokers complain they sold a home loan for $X and the wholesale buyer sold it within a week for $6,000 or 7,000 more.
You make a lot of people a lot of money when you take out a home loan.
Some of the biggest wholesale buyers are the big banks.
You could enter into an agreement with mortgage brokers whereby you pay them directly and there’s no spread premium (they do not get paid more if you get a higher interest rate loan).
Mortgage Broker Pitfall
Sometimes, your broker has a particularly good relationship with a particular wholesale buyer (they pay better, they are easier to work with, etc.). In this case, many mortgage brokers try to get every customer they have to go through that wholesale buyer, even when there isn’t a good match.
That’s one of the occasions when your mortgage broker will ask you if you can bring extra money at the closing, if you have someone willing to co-sign. It is also when some mortgage brokers break the law.
As different mortgage brokers have different buyers for the home loans they generate, different overhead and different profit margin needs, you get different interest rates. All of them and all lenders base whatever interest rate they quote you on the same thing, the rate the FED charges banks when banks borrow money from the fed.
Not Your Mortgage Broker’s Fault
Mortgage brokers have to work within this system, unless they’re also a portfolio lender. To be a portfolio lender for all the mortgages they generate, brokers would have to have a lot of money, hundreds of millions. And, you’ve guessed it, most of them don’t have that kind of money in their wildest dreams.