An understanding of how brokers are compensated is essential for borrowers. Your mortgage interest rate and the fees you pay to obtain the loan are driven by the manner in which the broker is compensated for the loan.
HOW THE PIPER GETS PAID: There are three components to broker compensation.
· The brokerage is sometimes paid by the borrower - The "Loan Origination Fee" or the "Loan Discount Points" are examples of the fees paid by borrowers that normally flow to the brokerage. These fees are clearly itemized on your Good Faith Estimate. [Points sometimes flow to the lender if the borrower is “buying down” a mortgage rate]
· The brokerage is sometimes paid by the lender - The company that lends you the money, the lender, will pay the brokerage a "Yield Spread Premium (YSP)," usually between 0%-4.00%, based on the interest rate of the loan. These fees are normally not itemized on your Good Faith Estimate (as an UpFront Broker, I do itemize them). The higher the interest rate, the higher the YSP. For example:
§ An interest rate of 6.500% from a lender on a $350,000 30-yr fixed rate loan may generate a YSP of 2.350% for the brokerage = $8,225. At this interest rate the monthly Principle & Interest (P&I) payment would be $2,212.
§ However, if the broker secured this same loan, from the same lender at a 5.000% interest rate, the loan may generate only 0.250% YSP = $875. At his interest rate the monthly P&I would be $1,879, a savings of $333 per month to the borrower compared to the first example.
· Finally, the brokerage is often paid by both the borrower and the lender.
§ The borrower may, for example, pay a Loan Origination Fee of 1.000% of the loan amount, and
§ the lender may pay the brokerage a YSP of 1.000%.
The brokerage’s gross profit or compensation would be 2.000%, of which 1.000% would be paid by the borrower. However
§ Remember that the interest rate on the loan would probably have been lower if the broker had negotiated an interest rate that had no YSP (commonly known as par). The lower rate would have yielded a lower monthly payment that, over a period of time, will generate savings exceeding the 1.000% paid by the lender. Let’s look at that $350,000 loan:
o At a 6.50% interest rate, in 20 years, the borrower will have paid $375,766 in interest and $155,172 toward the principle of the loan. In this case the borrower paid 1.000% of the fee and the lender paid 1.000%;
o At 5.000% interest rate, in 20 years, the borrower will have paid $278,073 in interest and $172,877 toward the principle of the loan; in this case the borrower paid 2.000%, the full fee, and the lender paid nothing.
o At a 5.000% interest rate the borrower will save over $90,000 in interest alone. The question: was it better to save $3,000 at closing (which would have been rolled into the new loan amount) or was it better to save over $90,000 in 20 years?
PAYING THE PIPER - STRATEGIES FOR PAYING THE BROKER
· Once the manner of compensation is established, the broker and the client together establish how the client would like to manage the payment of the broker’s compensation. You can:
§ Roll the compensation into the new loan amount and pay for it in a combination of Loan Origination Fee or Points (preferred by 99% of borrowers). Alternatively, you may just elect to pay broker when the loan settles and lower your new loan amount.
§ Allow the lender to pay the broker’s compensation directly to the brokerage in the form of a YSP; that will not increase your loan amount but will surely increase your interest rate.
§ Pay part of the compensation in the form of a Loan Origination Fee or Points and part in the form of YSP. A balance between the two will yield a slightly higher loan amount and a slightly higher interest rate
CLEARING UP SOME MISCONCEPTIONS: Finally, let’s take care of some common areas of misunderstanding.
· "UpFront Mortgage Brokers are cheap" Like almost everyone, I perform a service and expect reasonable compensation for the service I provide. I’m not the cheapest and I’m far from being the most expensive. I offer you competence, integrity, transparency, candor, a sense of urgency, and dedication, and, moreover, access to over 780 of the nation’s lenders and thousands of loan programs.
· "The client has to pay the broker’s compensation out-of-pocket" You do not have to pay the brokerage’s fees “up front” or “out of pocket” unless you wish to. The brokerage’s fees are normally rolled into the new loan or they are paid directly to us by the lender. About 98% of my clients elect to roll the compensation and other expenses into the new loan.
· "Do you charge for initial consultations and preparing the loan?” There is no charge for consultation, for researching different loan programs, for developing different scenarios for your review, for preparing applications, for taking application, for conducting credit checks, and for locking in a loan rate. If there are charges associated with these activities, either my brokerage or I absorb them as a cost of doing business. The compensation will be paid at settlement, when the loan closes.
· “Are you really compensated differently than other brokers? No. We’re compensated exactly like other brokers. The difference is that you will know precisely how much we’re compensated, precisely where that money is coming from, and that we are working for you. Nothing is hidden from you.
· "When all is said and done, are you any different than a regular mortgage broker" Yes, we are!!! UpFront Mortgage Brokers are hired by you to work in your best interest. The object of the exercise is to get you the best possible deal based on your desires & requirements. Will other brokers make the same commitment that we, as UpFront Mortgage Brokers, willingly take? Will they pledge to:
§ be the client's representative or agent, and endeavor to act in the best interests of the client.
§ establish a price for services upfront, in writing, based on information provided by the client.
o The price may be a fixed dollar amount, a percent of the loan, an hourly charge for the broker's time, or a combination of these.
o The price or prices will cover all the services provided by the broker. This includes loan processing, for which clients always pay a broker or lender.
o On third party services, such as an appraisal, ordered by the broker but paid for by the client, the broker will provide the client with a copy of the invoice from the third party service provider. Alternatively, the broker may have the payment made directly by the client to the third party service provider.
§ credit any payments received from third parties involved in the transaction to the client, unless such payments are included in the broker's fee.
o If the broker's fee is 1 point, for example, and the broker collects 1 point from the lender as a “yield spread premium”, the broker either charges the client 1 point and credits the client with the yield spread premium, or charges the client nothing and retains the yield spread premium.
§ use their best efforts to determine the loan type, features, and lender services that best meet the client's needs, and to find the best wholesale price for that loan
§ disclose the wholesale prices from which the broker's selection is made to the client.
§ provide a copy of the written confirmation of the rate lock as soon as it has been received from the lender.
STRATEGIES FOR DECISION
· Clients, who obtain fixed rate loans of 10 years or more, normally elect to roll their fee into the loan amount and take the lowest possible interest rate because they will save significantly in the long term.
· Clients, who obtain 1, 3 and 5-year adjustable rate mortgages (ARMs), may elect to take a slightly higher interest rate and have the lender pay at least part of their fee. They will be leaving this mortgage in short period of time and don’t want to significantly increase their mortgage balance.
· Clients who obtain interest only or option ARMs, normally take a slightly higher interest rated and have the lender pay the entire fee. Because they will be leaving the loan in a relatively short period of time, they wish to minimize the short-term cost of the loan.