In order to understand how a Mortgage Broker can offer lower rates and fees than Banks, Credit Unions or Retail Mortgage Lenders, you first need to understand what a Mortgage Broker is and how we obtain lending. As we discussed in our “What is a Mortgage Broker” article, misconceptions about Mortgage Brokers are common due to the lack of accurate information available online. As we answer this very important question, we’ll also discuss how we’re compensated because the two go hand in hand.
What is a Mortgage Broker?
A Mortgage Broker is a licensed and regulated financial professional who acts as an intermediary between borrowers and lenders. Mortgage Brokers have the ability to offer mortgage products from a network of wholesale lending channels and provide access to a greater range of products than Loan Officers (AKA Mortgage Bankers), who are limited to their own Bank, Credit Union or Retail Mortgage Lender’s offerings. Brokers also access interest rates at wholesale pricing which are lower than what a borrower can obtain on their own (retail pricing). Brokers don’t actually lend the funds for mortgages but rather originate and close loans on behalf of the borrower. Once the loan closes, the borrower makes their monthly payments directly to the lender/servicer but besides that, the borrower and lender don't interact with one another.
What is a Wholesale Mortgage Lender?
Mortgage Brokers don’t access lending like a borrower would. Instead, lenders provide what are known as wholesale mortgage channels that can only be accessed exclusively by Brokers. They are also referred to as Third Party Origination (TPO) channels. The Broker is an independent third-party performing all of the functions related to originating loans and the lender is simply underwriting the loan and providing the source of the funds. Since the Wholesale Lender only provides the lending, they aren't burdened by the following operating expenses that a Bank, Credit Union or Retail Mortgage Lender would. This ultimately allows the Wholesale Lender to offer much lower interest rates to the Broker than a Retail Lender can to a consumer.
A. Direct to Consumer Marketing/Advertising- Obtaining and retaining new clients is the most valuable asset in the entire mortgage market. Think of the Super Bowl commercials and endless barrage of advertisements you see for large powerful Retail Lenders and Banks. They spend hundreds of millions of dollars each year trying to reach consumers. On the other hand, Wholesale Lenders don't work with consumers, they solely rely on the Brokers they partner with to bring in new business.
B. Loan Officer Payroll (Origination)- Banks, Credit Unions and Retail Mortgage Lenders have to hire, train, and pay for licensing on behalf of their Mortgage Loan Originators (loan officers). They typically pay a generous salary, bonus and commission based on tenure and performance. Wholesale lenders simply utilize the Broker’s licensed LO’s, they don’t need to hire their own.
C. Customer Service Support- Banks, Credit Unions and Retail Mortgage Lenders have to hire large teams of customer support specialists. Wholesale Lenders only work directly with Brokers which maximizes efficiency and allows the Lender to focus on their primary service, Underwriting and Closing loans.
D. Additional Office Space- To support these additional operations mentioned above, Banks, Credit Unions and Retail Mortgage Lenders require much more office space than a Wholesale lender does. Office space can often be one of the highest expenses for a business.
E. Separate Business Units- Most Banks, Credit Unions and Retail Mortgage Lenders don't only offer mortgages. They're often in the business of selling other types of loans and/or financial products. Wholesale Lenders are solely focused on their primary services which maximizes efficiency and reduces risk.
Exhibit A:
This image shows that while Retail Lenders, Banks, and Wholesale Lenders usually start with the same base interest rates set by the Federal Reserve, Wholesale Lenders can offer lower rates to Brokers due to their lower overhead. Wholesale Lenders significantly reduce costs, particularly in marketing and origination, by outsourcing these tasks to Mortgage Brokers.
What are the different types of Wholesale Mortgage Lenders?
The three main types of wholesale lending channels Brokers can access are broken down into the following categories.
1. Wholesale (Only) Mortgage Lenders- These lenders are key when it comes to explaining how Mortgage Brokers obtain lower rates and fees. Wholesale (Only) Mortgage Lenders are lenders who work exclusively with Mortgage Brokers. An individual consumer can't go directly to this type of lender. As we discussed above, since they aren't burdened by the additional operating expenses, they can offer Brokers lower interest rates and fees while still generating revenue. It's like any product in a sense, if you buy it at wholesale prices, it's going to cost less. These lenders also typically invest more time and energy towards the Brokers success by offering additional tools and resources. United Wholesale Mortgage is an example of a Wholesale (Only) Mortgage Lender.
2. Retail/Wholesale Mortgage Lenders- These are mortgage lenders that have both retail (consumer facing) and wholesale channels. In other words, an individual borrower could go directly to the retail side of the lender or they could obtain the financing through that same lender using a Broker. The important difference is that the Broker obtains lower rates/pricing through the lender’s wholesale channel than the borrower could on the retail side. If they couldn't, Brokers would never partner with these types of Lenders. Also, the Retail and Wholesale divisions of a Lender are two separate segments with entirely different business models.
Accessing this type of Lender through a Broker also provides better client service, greater transparency and helps increase the chances you're working with someone experienced, not the Loan Officer you’re randomly assigned on the Retail side. In fact, many Retail/Wholesale Lenders are so confident that the consumer is better off working through a Broker, that if the consumer reaches out to both a Broker and the Retail division, the retail division will block the consumers ability to go through Retail. This is a really great example to illustrate that consumers are better off working with Brokers, even in the eyes of Retail Lenders themselves in some cases. Rocket Mortgage is an example of a Retail/Wholesale Mortgage Lender. The borrower could obtain their mortgage from Rocket’s retail side or the Broker can obtain it through Rocket’s wholesale channel called Rocket Pro TPO.
3. Banks/Credit Unions- Some Banks and Credit Unions also have wholesale lending channels that Mortgage Brokers can access. This is the least common of the three but there are still some great options in this channel. Similar to Retail/Wholesale Mortgage Lenders, Brokers obtain lower interest rates through a Banks wholesale channel than what a consumer could obtain directly on their retail side.
How do Brokers offer such low rates to borrowers?
As we've discussed, the core reason Mortgage Brokers can obtain lower interest rates is through their access to wholesale lending channels. They also have a wide variety of different lending options to choose from which increases competition among the wholesale lenders themselves. As a result, they offer Brokers even lower rates and incentives to earn their business.
The final factor involves how the Mortgage Broker operates as a business. Mortgage Broker companies are often smaller, which usually leads to lower overhead costs. With fewer employees, less office space, and streamlined processes, these brokers can run efficiently, providing competitive rates while maintaining personalized service. Also, unlike Banks and Retail Lenders, which invest heavily in marketing, brokers often depend on referrals, further reducing their operating expenses.
Exhibit B:
In comparison to Exhibit A, you can see that even though Mortgage Brokers incur their own overhead expenses on top of those of the Wholesale Lender, they can still provide borrowers with lower rates and fees. This setup allows both the Wholesale Lender and the Mortgage Broker to generate revenue while remaining the most advantageous option for consumers.
How does a Mortgage Broker get paid?
Now that you’ve read the important aspects about what a Mortgage Broker is and how we obtain Wholesale Lending, the way in which we’re compensated will make much more sense. Mortgage Brokers are compensated by either of the two methods below on a per loan basis. As we'll discuss, the type of compensation used for the loan depends on a variety of factors. Also, we can only be paid one of the two methods per loan, not a combination of the two.
The laws regarding Broker compensation are very strict and are designed to protect consumers. Also, neither Broker compensation method is necessarily better than the other, it usually depends on the structure of the loan and the specific circumstances.
Method A. Lender-Paid
On the vast majority of the loans we originate, we’re paid directly by the wholesale lender in which we obtain the lending through, not the borrower. We set our compensation agreement with the lender as a % of the loan amount, anywhere typically ranging from 1%-3%. We can only change these preset compensation agreements every few months so that we aren’t changing it for one specific loan. Typically the percent of the loan amount we set it to depends on the current state of the market. Our compensation is amongst the lowest you will find for a Michigan based Mortgage Brokerage. Another important thing to note is that by law, the compensation percentage we select must be the same at all of the lenders we’ve entered into agreements with (or will enter into agreements with) so that we aren’t incentivized to place loans based only on potential financial gain.
Although this compensation method is technically baked into the interest rate you receive, we’re obtaining wholesale rates as we discussed in the previous section. In other words, even after this Lender-Paid (% of the loan amount) compensation is baked in, the interest rate, fees, APR and overall cost to the borrower is still lower than the Banks, Credit Unions and/or Retail Mortgage Lenders in the vast majority of cases. Retail Lenders and Banks have to bake enormous operating costs into their rates, the difference is they do it behind the scenes. We obtain very low wholesale rates and have significantly lower operating costs which allows us to offer lower rates to our clients while still being to generate a profit as a company.
Here's another quick way to illustrate the Lender-Paid compensation method. Hypothetically speaking, let’s say a Broker was able to obtain a 5% interest rate for the client through a Wholesale Lender. After their (% of the loan amount) Lender-Paid compensation was baked in, it resulted in them offering it to the client at 5.5%. This same borrower then shopped around and went directly to a Retail Mortgage Lender that was only able to offer a 6% interest rate. Even though it’s technically baked into the rate, the Mortgage Broker would still be the better option for the borrower.
Method B. Borrower-Paid
Example 1:
In the rare case a competitor is offering our client more favorable terms (rates/fees/APR) and it’s evidenced to us in an Official Loan Estimate, we can switch the compensation structure to Borrower-Paid Compensation. To help ensure we beat out the competitor, we can use part of the compensation we would have received through the Lender-Paid method in order to lower the interest rate. Although the Loan Estimate will now indicate the borrower is paying us a Broker Fee in Section A of the Loan Estimate, they’ll likely see that we’re offering a lower interest rate/fees/APR and require less cash to close than the competitor. In other words, the Mortgage Broker in this case is actually making less money on the loan even though they had to switch to Borrower-Paid compensation.
Why is it showing a Broker Fee? If you recall, we can only change our compensation agreements every few months and we can only be compensated by one of the two methods per loan. When we flip it to Borrower-Paid to win the deal, our Lender-Paid compensation is no longer baked into the interest rate. We could hypothetically do the loan for 100% free and offer the client an incredibly low interest rate/APR. This is mentioned simply to illustrate once again that Brokers can rarely be beat in terms of low rates/fees/APR.
Example 2:
Another reason we may select Borrower-Paid is if the loan amount is relatively low. Since Lender Paid agreements are based on loan amount, we would barely make a profit if the loan amount were very small. Since we would still be doing the same amount of work, we often set a baseline minimum compensation amount of $1000-$1500 per loan. The exact amount depends on the loan type and complexity and would be laid out in the Loan Estimate. Please note that this absolutely doesn’t mean that Mortgage Brokers aren’t the best option just because a loan amount is low. It’s simply related to the way the compensation agreements are designed as well as the laws regarding LO compensation.
Example 3:
The final reason we might have to use the Borrower Paid method is for unique mortgage types such as an Adjustable-Rate Reverse Mortgage. There are certain mortgage products that lenders only offer when we set it to Borrower Paid. This is due to various compliance and legal issues regarding Broker compensation. These are rare and as with any loan, all of this will be fully disclosed in the Loan Estimate.
Summary:
Obtaining financing through a Mortgage Broker benefits consumers in every way possible, including the fact we offer lower rates and fees. Given that even a slight difference in interest rates can have a huge impact on the financial outcome, it's vital to work with a Mortgage Broker who can obtain lower rates than what are offered directly to consumers.
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