Why Use a Mortgage Broker?

My understanding is because you/Trillium shop around and can get better rates/terms, and can give loans to riskier borrowers like entrepreneurs such as myself, is this right? Why else?

As far as it goes, the above probably is what most people understand as the main advantage of using a mortgage professional.

The result of this belief is that most people only consider going to a broker to get the best interest rate rather than the best mortgage for them. And this distinction is the foundation of what a mortgage professional should be doing for most consumers. Far more consumers would use brokers if they truly understood the advantages to them of doing so.

There are actually many differences between lenders, and between mortgage products marketed even by the same lenders. Mortgage products are highly nuanced in their design, and actually there are major differences simply based on the type of mortgage obtained.

I’ll briefly cover some of the major differences:

1. Open vs closed mortgages. An open mortgage is simply a mortgage that can be paid off at any time without any penalty for being paid out early. Although an open mortgage always has a specific term, the term is simply the period at the end of which it must be paid out or renewed by the lender and borrower. Open mortgages are therefore more desirable for someone who may wish to pay off his mortgage prior to the end of a normal mortgage term, and are often preferred by real estate investors who buy and sell real estate as a business proposition. There are good reasons for the average consumer to avoid an open mortgage, primarily the fact that open mortgages have signicantly higher interest rates for the same term as a closed mortgage.

2. The term of the mortgage. Mortgages range in term from six months to forty years. In Canada there are mortgages available from six months to 10 year terms. The term is simply the period at the end of which a mortgage must be paid out or renewed by mutual agreement of the lender and borrower. Popular terms for mortgages are six month, one year, two year, three year, four year and five year. Seven and Ten Year mortgage terms have been recently reintroduced to the market and are gaining some popularity with people who want a high level of certainty in their mortgage costs over a long period. Different terms often reflect different interest rates to be charged for the duration of the loan. Sometimes longer term mortgages are more expensive and sometimes less. These changes in interest rates, based on terms, are critical to a borrower getting the right deal to meet their situation. A wrong choice for a consumer can have serious long term consequences including major cost differences upon the sale or refinance of a property. Picking a mortgage term and rate without analysing a borrower’s situation is like buying a vehicle without knowing what it is going to be used for. Would you drive a dump truck back and forth to work every day? Not likely, but sometimes a mortgage picked without consideration of various issues is at least as inappropriate as using a sportscar to haul cement to a construction site.

3. Amortization. The period of time over which the principle of a mortgage is paid off by periodic payments. Historically most mortgages in Canada are twenty-five year amortizations. In the last few years the lenders have made other, longer term mortgages available. This has the effect of reducing the monthly payment needed to pay the mortgage payment, but increasing the length of time that a person has to pay that payment. The net effects of a longer amortization period are both good and bad, including making housing more affordable for new home buyers, but also keeping people paying mortgages long after their retirements, or forcing people to postponing their retirements. Historically Canadians paid off their mortgages long before retirement. This is no longer true in major urban markets due to a combination of high housing costs and other economic factors that determine the relative allocation of income to paying off a borrowers debts.

4. Variable vs fixed mortgages. Variable mortgages are mortgages where interest rates fluctuate over the term of the mortgage, based on a relationship to the bank prime rate. Historically variable mortgages were considered to be superior to fixed rate mortgages in assuring the lowest possible cost for mortgage financing over the term of the mortgage. However, since the collapse of cheap money from the US bond market, variable rates have fallen out of favour due to their increased costs. Bank have increased variable rates significantly since the US financial collapse. Most brokers today recommend against variable rates except under special circumstances. There are still situations where variable rate mortgage make sense, and a mortgage broker will consider those alternatives when making a recommendation to a client.

5. Conventional vs insured mortgages. If you want to purchase a home in Canada, and you have less than 20% of the purchase price for a downpayment, and you want the best interest rate in the market, you will be required by your institutional lender to qualify for and pay for mortgage insurance. This specialized insurance product insures the lender against loss caused by default from non-payment for any reason. In other words it eliminates the risk that a borrower will fail to pay the mortgage, and allows the lenders to lend money at what would otherwise be an uneconomic rate of return. By the passing the risk of foreclosure off to an insurance company (CMHC) or (Genworth) banks and other institutional lenders reduce dramatically their costs associated with risk management. The insurance is paid for by the borrowers, but its direct benefit is to the lenders, as borrowers in Canada (generally) are still liable for any shortfall paid by the insurance company. The only benefit to consumers is that it makes mortgages substantially cheaper than they would be in the absence of this insurance. Insurance premiums are paid at the beginning of the mortgage out of the proceeds of the mortgage loan at range from 2.5% of the borrowed amounts up to 6.5%. Loan below 80% of the value of the purchased property do not always require insurance, and are known as conventional mortgages, however it is increasing common for lenders to insure these mortgages as well, but without charging the consumer a direct mortgage insurance premium. The advantage to a lender is that insured mortgages are marketable in the bond marketplace, whereas uninsured mortgages are not (at the present time, although they may become so again in the near future if US financial markets continue to improve).

6. First, second and other mortgages. Most people don’t know that a second mortgage is only a second mortgage because it is registered later on the title of a property than the “first” mortgage. Second mortgages have become increasingly popular as a means of obtain additional capital between the end of terms of various bank mortgages, as they may be less expensive, overall, than rewriting a first and incurring a mortgage penalty. Also, many people who cannot get a new first mortgage because their credit has been damaged by circumstances or unemployment, can borrow under a second mortgage, pay off their other debts, and improve their credit rating. This then allows them to qualify for a new insured (lower cost) first mortgage.

7. Mortgage Life Insurance. While mortgage life insurance is sold by virtually every bank and institutional lender in the Canadian marketplace there are substantial differences in the nature of the life insurance purchased from a bank compared to comparable products sold by mortgage brokers. Banks typically sell insurance where the underwriting takes place after a claim is made. As unbelievable as this seems to the uninitiated, what it means is that if someone has bank sold life or disability insurance, and then they make a claim, it is the insurance company’s policy to challenge the claim by requiring medical evidence be obtained from the deceased person’s doctor or disabled person’s doctor that the insurance company can use to disqualify any claim, by claiming that the insured person had a pre-existing condition which means that they weren’t really insured at all. The bank will refund the premiums collected from the borrower, but his heirs are out of luck as is he if he disabled. Brokers have access to mortgage life insurance that is underwritten prior to the policy being issued, so that if a policy is issued, and there is a claim under the policy, except for fraud, the claim is paid as expected. In addition, life insurance sold by the banks is automatically cancelled if the mortgage is refinanced through another lender. With broker supplied mortgage life insurance the policy is not affected by a change in lenders.

The above differences between different mortgage products and services demonstrates the value of using a mortgage professional to choose your mortgage and mortgage provider, however, a mortgage professional provides many addition benefits to a borrower including facilitiation of meeting the requirements set out by a lender when they approve a mortgage loan. A good broker will ensure that a borrower is well prepared to meet these requirements prior to actually applying for a mortgage, including advising the borrower as to the documentation to be required such as:

1. Evidence of income for at least two previous years

2. Job proof

3. Purchase and Sale document of all sorts

4. Information about property such as heat, water, local utilities, type of construction, etc.

5. Other documents needed by the lenders

Finally, a mortgage professional will monitor your mortgage so that six months before its term is over, the broker will contact you to ensure that you are given the best alternatives available to replace the mortgage.

And these are only the highlights of what a professional mortgage broker does for his clients. It’s a lot more than just shop for a cheap rate. However, that’s not the end of it.

Brokers don’t generally shop your mortgage at all but rather place your mortgage with a lender based on a complex set of considerations one of which is the best rate available for the client under the circumstances. As discussed above, the cheapest rate is not always the best rate for a given client’s situation and a lender with the cheapest rate for a given term and type of mortgage may still not be the best choice. Banks and lenders generally are in a service business, and the quality and diversity of their services also enters into consideration. In addition lenders decide which brokers have the right to submit business to them and reward their chosen brokers very well with bonuses and other financial and other considerations for sending them business.

In an ideal world brokers would never choose to send a deal to a bank just because they would receive a higher commission for doing so. Given human nature, and the fact that banks and lenders would not provide bonuses and other compensation unless it worked to cause brokers to send them deals, it is highly likely that brokers are influenced by the compensation earned.

In most provinces there is Conflict of Interest legislation which requires disclosure of a financial relationship between a lender and mortgage broker. I generally don’t believe that it goes far enough but disclosure rules are designed to flush out bad apples, not professionals operating ethically.

But lest you think that the banker isn’t in the same potential conflict of interest, think again. Your bank loans officer has no conflict of interest, because he or she has NO DUTY OF CARE to the borrower at all. His obligation is to meet bank policy and write loans that fit bank rules. If a borrower doesn’t fit the bank criteria, well, then it's just too bad, and the borrower will be declined, in a manner that will leave the borrower feeling less than satisfied with the outcome, and without any assurance that any alternatives have been considered or presented.

By the way, shopping the mortgage as it were, putting up a deal for bidding by multiple lenders is not permitted by most lenders. Brokers are expected to submit deals to one lender at a time, only submitting it elsewhere after a reasonable period of time for the lender to respond.

There are many issues related to getting a mortgage for the average person, and despite the potential for conflict of interest by a broker, a person is far better off getting advice and support from an Accredited Mortgage Professional (AMP).

Choose a professional broker who has earned his Accredited Mortgage Professional accreditation from the Canadian Association of Mortgage Professionals, and ask questions. Is he or she really interested in you and your needs as a borrower? Or is he or she simply in a rush to get your mortgage done quickly, without being particularly concerned about the details of your situation.

Conflict of Interest

Conflict of Interest is something that few people consider in their day-to-day lives that absolutely must govern the conduct of a financial services adviser, such as a mortgage broker, yours truly.

There are any number of ways that a conflict of interest may arise for a mortgage broker, any of them significant to the potential victim of the conflict of interest.

I will define a conflict of interest as follows, "A confict of interest is the result of an imbalance of power created by an advisor's ability to gain the trust of a client, when in the present of that trust, the client relies on information provided to the client that fails to disclose relevant information known to the advisor but not to the client, such information causing potential harm to the interests of the client."

Another way to put this, is to say that, "anything known which may have a tendancy to cause a client not to engage in a contract, must be disclosed prior to the client completing the contract. This is particularly true when an advisor acts as an agent for the client, and using superior knowledge or skill on a client's behalf."

For brokers there is certain information they are expected to provide as a part of their normal due diligence, and while the precise information required depends upon the specific details of a given mortgage arrangement, due diligence is required of a broker. It is not enough for a broker to say, "I didn't look, so I therefore didn't know."

In the day-to-day lives of mortgage brokers there are several situations which commonly occur, particularly when a broker is representing a borrower and a lender in the same transaction. It is a rule of ethics, and of law, that the broker fully disclose any compensation he is receiving from either party to the other party, and that there be no secret commissions or compensation, as the party not in possession of this information may conclude that the broker is being influenced by such an undisclosed payment.

There are other potential conflicts of interest, such as when a borrower client tells a broker confidential information, which if disclosed to a lender would result in a mortgage loan being declined, such as information that the borrower is just about to lose a job. In such a situation, where the right to confidentiality of one party potentially violates the right of the other party to full disclosure the broker may very well find himself in a position of having to withdraw entirely from the file and cancel the application for the mortgage prior to completion, as this situation would result in an improper outcome if the information is withheld. On the other hand the borrower has a legitimate right to have his or her confidentiality preserved.

In such a no-win scenario a broker has no choice but to withdraw from the transaction altogether because there is no way he can legitimately balance the rights of both parties.

Many times a potential conflict of interest arises because the lender is paying the broker's commission or finder's fees while the broker is simultaneously acting for the borrower. This is the most common conflict of interest experienced by mortgage brokers acting to place mortgages with institutional lenders such as the banks, who generally pay all of the broker's fees. Just because the bank is paying the freight does not mean that the broker has no obligation to the borrower, on the contrary. The broker must balance his duties to the two parties carefully, to ensure that he fulfills his fiduciary responsibility to his borrower while at the same time ensuring full disclosure of all relevant information to the lender.

In most provinces there is legislation mandating specific forms of disclosure of this last type of conflict of interest, which allows the broker to deal with the potential confict of interest, and the harm it could cause a borrower, by fully disclosing that conflict of interest in the course of the transaction.

Although much more could be written about the potential conflicts of interest arising out of a brokers responsibilities to both borrowers and lenders, the bottom line is full disclosure of all material information to both parties at the time of any transaction. Any deficiency in disclosure, either statutory or ethical, is unacceptable as it has the potential to harm the financial interest of either the lender or the borrower.

Ultimately, both lenders and borrowers (ie: investors) need to accept personal accountability for their own lending and borrowing decisions, something only possible if they are in possession of all relevant information.

There are severe potential financial, legal and regulatory consequences for the financial advisor who does not takes his duty of disclosure seriously or his obligation to his clients to balance fairly the interests of both the borrower and lender.

In the context of investing in mortgages or mortgage investments generally it is critical that investors read the disclosure documents closely whether the Mortgage Investment Disclosure Form as defined by the Form 9 in British Columbia, or by an Offering Memorandum for an investment in a mortgage investment corporation. It is extremely important to review all documents provided by your broker or other investment advisor in order to satisfy yourself that everything needed for you to make a decision is present.

Broker or Bank - The Borrower's Dilemma

The differential advantage to a borrower for using a broker is NOT the fact that the broker sends a mortgage deal to a non bank lender, it is the goal that a broker will obtain the best available deal for the borrower, from a bank or a non bank lender.

Brokers should have no loyalty to a particular lender, although it would be disingenuous to suggest that bonusing arrangements have no impact on mortgage placements with different lenders.

Also, commission rates vary from one lender to another, and from one product to another, which means that some brokers measure their income from a deal before they figure out what the best deal for the borrower could be.

These things mean that brokers are inherently in a conflict of interest with a prime "A" borrower because the placement of the loan can have a huge impact on how much the A broker will earn.

In British Columbia the Financial Institutions Commission recognises the potential for conflict of interest, and requires brokers to sign a disclosure of the conflict of interest, as well as a disclosure form which details any fees paid by the borrower directly to the broker. However, fees paid by the lenders to a broker are not disclosed in any required forms in BC, something that probably should be remedied in due course.

This is not only an issue for mortgage brokers. All consultants who make their living by being paid for the placement of products or services to their clients are also generally in a conflict of interest, and are to some degree driven to sell products based on what they earn from doing so. So the main difference with mortgage brokers is that the service we sell is fundamentally different in that we represent vendors of the single largest expense in most of our clients' lives - their mortgage.

Undisclosed differences in payments by different vendors of loans drives some brokers to make recommendations based almost entirely on how much money they will make by placing the deal with one lender or another.

The thing that protects the public from being abused by the conflict of interest is that the mortgage brokerage industry is incredibly competitive - any broker who acted contrary to the client's best interest would probably soon find himself out of business with no clients.

It is one of the distinctions that separate private loan brokers from A lender brokers. When someone borrows money from a private lender through a broker there is no failure to disclose. All brokers fees, appraisals, inspections, etc. are paid for directly by the borrower and the borrower is fully aware of any and all out of pocket costs, which include all payments made to the brokers.

So while most "A" brokers tell you that you will pay no fees for their services, what they don't tell you is that the method by which they earn their fees may be inherently contrary to the borrower's best interest.

At the very least the rules of the industry should require that these fees be fully disclosed, so that the borrower may make a fully informed decision about the relative merit of the advice he or she is receiving.

As for the conflict of interest a borrower encounters by going directly to a bank - there is no conflict of interest: the bank employee represents the best interests of the bank, only the bank and always the bank.

So a borrower has to make the best of two choices, one with the potential for a conflict of interest (the broker) or the one with no conflict of interest (the banker) since the bank always acts in its own self interest.