A mortgage broker is a professional who helps borrowers find and apply for the best mortgage loan according to their needs. A mortgage broker is typically approved with several wholesale mortgage lenders, and typically have access to a wider range of products and programs, while boasting the ability to get better rates than traditional retail mortgage lenders. The broker is typically compensated for their services in one of two ways: lender-paid or borrower-paid. Which method is chosen is often a strategic decision between the broker, and their client.
Defining Borrower-Paid and Lender-Paid
Lender-Paid
With lender-paid, the mortgage broker is compensated by the wholesale lender for their services. This means that the wholesale lender pays the broker a fee for finding and securing a mortgage loan for the borrower.
The fee is typically a percentage of the loan amount, and it is typically built into the interest rate of the loan. The borrower only pays closing costs related to the refinance or purchase transaction, either out of pocket, through the loan, or both, for the remainder of the services, such as closing costs related to title insurance, credit reporting, escrow closing services, impound accounts and various other charges.
Borrower-Paid
With borrower-paid, the mortgage broker is compensated by the borrower for their services. This means that the borrower pays the broker a fee for finding and securing a mortgage loan for them.
The fee is typically a flat rate or a percentage of the loan amount, and it is collected from the borrower by the title/escrow company during the closing process. The title/escrow company then disburses the funds to all of the parties to the transaction, including the broker and their compensation. It is highly uncommon for the borrower to directly pay the broker without an intermediary involved.
In both cases, the mortgage broker’s goal is to help the borrower find the best mortgage loan for their needs at the lowest possible rate.
Strategic Decision for Which Compensation to Use
Borrower-paid compensation almost always have lower interest rates than lender-paid compensation rates do. Although the rate is lower with borrower-paid, the borrower will have a higher out of pocket expense for closing costs, so which one makes sense is a relative decision.
Determining which compensation method, a broker uses is a decision that needs to be made carefully between the broker and their borrower. Various factors will come into play, such as:
- The loan-to-value ratio of the final loan amount
- The credit scores of the borrowers
- The borrowers need to reduce out of pocket expenses for the loan
- The fluctuation of the mortgage interest rates at any given point
- Whether it is a refinance, refinance cash out, or purchase loan
There are several more factors that go into strategizing which compensation method to use, but ultimately it comes down to this objective for brokers: balancing how to get borrowers the lowest interest rate, while also keeping the out-of-pocket expenses as low as possible.
This is not an exact science, but more so a strategic decision based on facts. With that said, the majority of mortgage loans originated in the United States use the Lender-Paid compensation method.
Why Some Mortgage Brokers Get Better Rates Than Competing Lenders?
Mortgage brokers may be able to offer better interest rates to their borrowers from their respective competitors for a few different reasons.
First, mortgage brokers often have relationships with a variety of lenders, including banks, credit unions, and other financial institutions. This means that they have access to a wide range of wholesale financing options and mortgage products to choose from. Competing wholesale lenders have varying interest rates for the same mortgage products so it will depend on which wholesale lender the broker is placing a specific borrower loan with.
Second, mortgage brokers may have more negotiating power with lenders than individual borrowers do. This is because mortgage brokers often bring a large volume of business to lenders, and lenders may be willing to offer better rates in order to secure that business with a specific broker.
Third, some mortgage brokers may have specialized knowledge and expertise in the mortgage industry that allows them to find a wholesale lender with the best rates for their borrowers on a specific mortgage program or product.
Fourth, the compensation a broker makes from a wholesale lender relationship will impact the interest rates available for borrowers. If a mortgage broker wants to get paid, say 2% of the loan amount as their compensation from the wholesale lender, this brokers rates for lender-paid pricing available to their borrowers are going to be higher than a competing mortgage broker who wants to only receive 1.50% of the loan amount as compensation from the wholesale lender. Essentially, a lower lender-paid broker compensation could mean lower lender-paid interest rates on a given product or program.
Overall, the ability of a mortgage broker to offer competitive interest rates to their borrowers will depend on a variety of factors, including their relationships with lenders, their negotiating power, and their expertise in the mortgage industry, and the compensation agreement between broker and wholesaler.
