Lending money is one of the best, oldest and most profitable businesses in the world. That's how banks make money and in the process power an economy, by empowering consumers with buying power. There are two ways in which you can go shopping around for a loan. You can either approach banks through their direct retail channels or go through a mortgage company that acts as the mediator between you and the bank.
If you are planning to take the second route, it's essential that you know mortgage companies operate and make money. While it's true that they operate in the best interest of their customers, you cannot deny the fact that they are out there to make money. In this WealthHow article, I acquaint you with the modus operandi of mortgage brokers and the way in which they earn money.
How Do Mortgage Companies Work?
Every field of business has a species called the 'Middleman' as part of its ecosystem, who has the connections and know-how to make things happen. Mortgage companies are the premier middlemen of finance, acting as intermediaries between credit offering financial institutions and the end consumer and businesses, to serve their credit needs.
There are banks, credit unions and financial agencies who are willing to offer credit to consumers. Out of this variety, choosing the right financial institution which offers the best mortgage loan deal for a consumer, according to his financial status and credit score, can be a tough job. That's where mortgage brokers offer their expertise. On one hand, they have access to bankers and private lenders and on the other, they deal with consumers in need of credit.
Assessing the risk of granting a loan to a consumer, determining his exact requirements and finding a lender who could provide a loan at the most reasonable price, is the job of the mortgage broker. He performs the job of studying the financial records of the loan applicant, his credit history, handling the paperwork and contacting the lenders for a loan approval, after consulting with the consumer about the loan conditions offered. He earns a commission by charging points to the consumer, which are unit percentages of the approved loan amount.
How Do Mortgage Companies Earn Money?
So now we attack the central question of how does a mortgage broker make money? It's just like how all middlemen do. It is by charging fees for his 'matchmaking' services. For the underwriting services, credit counseling and documentation that the company handles for you, it will charge you with a fee, in the form of points. For example, for a loan amount of a $100,000 at 7.5% interest rate, the broker might charge 1.5 points as fees. That is, he will charge, 1.5% of the loan amount sanctioned as fees. In this case, 1.5% of $100,000 is $1,500, which is the fee you'll have to pay the broker for getting a loan at a low interest rate.
Another source of income for the mortgage companies is the 'Yield Spread Premium (YSP)' which is the incentive or rebate from the lender for getting a loan sanctioned at a higher interest rate, for which the borrower is charged. The YSP profit is a controversial issue as it is looked upon as an incentive to brokers to get higher interest rates, which works against their primary objective of consumer welfare, who are looking for loans at lower interest rates. In USA, it is mandatory that the broker disclose the YSP while closing the deal. Most brokers will charge a high YSP, in return of a lowering of upfront loan processing costs.
So this is how mortgage companies operate to make money by acting as the middlemen between wholesale lenders and consumers. To summarize, all mortgage brokers earn through fees charged for their credit counseling, loan underwriting and loan processing services. This commission is earned through points that they charge the customers for the service as origination fees and the YSP. If you are not happy with paying commissions to your broker, you always have the option of approaching lenders directly through their retail channels.
The advantage of going to a broker lies in the variety of loan deals he can provide you and select the best ones that you can qualify for, according to credit history. That's why more than half the loans processed in USA, go through mortgage companies. The best way is to compare such companies and select the one with best track record, known for its customer-centric services. Just make sure that you make the mortgage broker earn his commission!