By: Sarah Colucci (January 8, 2018)
Consumers are aware that mortgage brokers and financial institutions flight to save their client's money. Competition is intense on all fronts. Credit unions, major banks, monolines and, of course, in between themselves (i.e., Mortgage brokers vs. in-house bank and credit union staff). So, how does a consumer pick the best avenue for financing?
Mortgage rates are usually the main highlighted item that somehow convinces consumers that they will get the best deal. Websites such as ratespy.ca and ratehub.ca elude that interest rates are the most crucial factor in getting a mortgage. The names of these websites also display their objective. Interest rates are essential; however, prepayment penalties and the flexibility of the mortgage are just as significant. In my opinion, it's unfortunate that consumers are not publicly alerted about the consequences of only thinking about the rate.
Take pre-payment penalties, for example. The prepayment penalty business is a multi-billion dollar industry. If a customer is initially set up to fail because they signed a lousy mortgage contract, the interest rate they received won't matter. For example, in the all-too-common situation of a purchaser locking into a five-year fixed rate. Here's how. Firstly, if they got a mortgage with a financial institution that uses higher-than-usual posted-rates (ex. using the Bank of Canada's benchmark rates to calculate their penalties). If that purchaser needs to exit their mortgage within the term because of life circumstances, they will pay the most amount of money to do so. On the flipside, if they got the same mortgage with a lender that didn't use the Bank of Canada's benchmark rates but, instead, used lower rates in their calculations, their penalty would be smaller. This difference could easily equate to over $10,000 in savings for that purchaser. BUT, in reality, financial institutions, who are in the business to make money, keep their revenue streams flowing from the ignorance of the ordinary borrower (and from working with the wrong professionals, too). Also, professionals who may not be able to show their clients the benefits of thinking outside of just the rate may lose the war against "rate shoppers."
When it comes to flexibility.
The devil is definitely in the details when it comes to mortgage contracts. Most borrowers want to pay less money for their mortgage - that is their primary objective. So, they erroneously believe that getting the best rate equals lower monthly payments which then equals being mortgage free sooner. Unfortunately, this is not always the case, and a simple assumption like this could have serious financial consequences.
When certain lenders offer their "lowest rates," the terms are usually punitive. This means that real money-saving privileges like doubling up on or increasing monthly payments are not allowed. When a borrower can increase their mortgage payment or double up on their payments, more principal, and less interest are paid. Missing an opportunity to do this has the reverse effect of what they initially set out to do - be mortgage free sooner.
Extra fees/mortgage broker and bank compensation model
There is some confusion amidst the general public about how mortgage brokers get paid. It's a no-brainer that both the bank and the broker channel compete for business but how do each get paid and how can that affect the money the consumer will save or spend?
Firstly, mortgage brokers can get paid two ways. 1. They can charge a broker fee. 2. They get paid by the financial institution that approves the borrower's application.
When a financial institution approves an application for a residential mortgage, the broker is paid by them. This payment is called an origination fee. What this means is the lender will pay the broker a commission for referring an application to them. The borrower will not pay any fees. Sometimes, depending on the work that was involved in getting the file approved, a broker may choose to charge a broker fee, which would be paid by the borrower. In this case, it would depend on who the purchaser decided to work with as NOT ALL brokers charge a broker fee on top of the compensation they are already receiving.
In some cases, there will be no compensation to the mortgage broker from the financial institution. Usually, this happens when arranging commercial and private loans. If a purchaser is organizing this type of financing through a mortgage broker, they should expect to pay a brokerage fee.
The main benefits of working with a mortgage broker are that their success depends on the following:
1. getting a borrower approved
2. finding them the best deal by consulting a wide range of lenders, including but not limited to major banks and credit unions.
3. generating repeat business and a referral source.
Compensation model for major banks
Mortgage Specialists employed by major banks are usually not accredited and don't have any specific certification with governing bodies (for example, mortgage agents and brokers are licensed by FSCO). They typically get incentivized by the bank they work for based on the volume they do. For example, their raises and bonuses and in some cases, even employment, depend on them arranging to finance property and/or offering other credit products. There are no fees ever charged to the borrowers concerning lender/broker fees.
Some of the downsides of working for major banks include:
1. limited resources to consult when applying for approval. Meaning, the banks don't have access to the funds of many other lenders currently available.
2. Not licensed (less information available to the consumer).
Benefits would include no fees getting charged to the client, waived appraisal fees (which are usually paid for by brokers as well).
Overall, the main lessons borrowers should learn are:
1. Mortgage contracts have "fine print" which should be read carefully by borrowers to ensure they are getting the best deal.
2. Borrowers shouldn't rely on what a mortgage broker or bank specialist tells them. They should do their due diligence - ask questions, read the contracts.
3. The interest rate, although significant, is not the most critical part of a mortgage contract.
4. Calculate prepayment penalties with multiple lenders to see the cheapest option before you sign on the dotted line.