There used to be a time when you could send in an application to hold a rate with a lender, and then cancel that application without too many repercussions.
Not these days.
Lenders have been intently focusing on an all-important statistic called the “funding ratio.”
The funding ratio =
Mortgage applications submitted to a lender / Mortgage applications closed with that lender
It is a percentage that tells lenders roughly how efficient a mortgage planner is.
For example, if an agent submits 10 applications to a lender and only three of them close, that planner’s funding ratio is 30%. That’s enough to get the agent “cut off’” at some lenders.
The reason is that cancellations and declines cost the lender money. The costs include:
- Hedging expense (the lender’s cost of holding your rate)
- Underwriting time (salaries)
- Support staff time (salaries)
- Overhead (the portion allocated to the application)
Years ago when per-deal profits were wider it wasn’t as much of an issue. With today’s intense competition and tight margins, it is.
For these reasons, mortgage planners must be more and more careful when they send applications to lenders. Agents must be confident that:
- The client’s application will be approved
- The client’s pre-approval will turn into a “live” deal
- The borrower will close after the mortgage is approved
As a borrower, this means you should be sure of your decision when you choose a particular lender. You’ll want to do all your shopping beforehand, and be happy with a lender’s rates and terms at the time you apply.
In general, it can be difficult for a mortgage professional to move an application from lender to lender without good reason. What constitutes a good reason? One example is when a new product comes out that offers significantly better features (or a much lower rate) than what you were approved for.
On the other hand, assuming the agent got you the best deal at the time of application, made the most suitable recommendation, and fully explained the product, then a five basis points rate drop somewhere else is usually not a good enough reason to switch lenders.
Mortgage planners who make a habit of moving or cancelling applications are taking chances with their careers. Best case, they annoy their lenders. Worst case, they are blocked from dealing with certain lenders–and that curtails lending options, which hurts all of that agent’s future customers.
…then a five basis points rate drop somewhere else is usually not a good enough reason to switch lenders.
Huh? Not good enough for who? Are you telling me that consumers should accept a worse deal (even if only 5 basis points worse) because it will make Brokers look bad if they don’t?
Sorry, I don’t think so. If Brokers are punished for getting their clients the best deal possible, then that’s a flaw in the system, not a flaw in the consumer.
Hi Bob,
Thanks for the comment. This is fuel for a good dialog and it’s the reason this story was written.
I absolutely agree with you that the system is not perfect, and it can’t be, because everyone’s interest must be weighed fairly.
It is not about making a broker “look bad.” It is about preserving choice for customers. If a broker loses his/her ability to use a particular lender, then the next customer suffers and no one wins in the long run.
Lenders could of course choose to not provide disincentives for canceling applications, and that would allow applications to move freely from lender to lender. The problems with this would be twofold:
1) Rates would increase to reflect the added costs to lenders. Customers would then be no better off; and,
2) In most cases, it would add inefficiencies to the process that have greater harm than the good of a 5 basis points rate improvement (again, assuming the customer was quoted and received the very best deal at the time of the original application).
In sum, the system is designed the way it is for a purpose. However, it’s worth stressing that if a materially better product or rate does become available after approval, mortgage planners typically try to secure the same terms at the customer’s current lender, and are always willing to take the deal elsewhere if required.
In the end, the economics often don’t amount to much. Sometimes 5 bps is just a few dollars a month and sometimes the product features outweigh the rate differential. Moreover, we find that nine times out of ten people tend to value their time sufficiently such that re-applying all over again isn’t worth the 5 bps.
In any event, hopefully the above sheds a little more light on things.
All the best,
-Rob
I’m, frankly, skeptical about the calculus, and I think that the “purpose” you state (In sum, the system is designed the way it is for a purpose.”) is not really to “preserve choice for customers”.
Frankly, that is at odds with the business model of every single mortgage lender — each of which is attempting to shrink choice by –ideally– becoming the only game in town.
“Preserving choice for customers” by restricting their ability to choose the best deal possible doesn’t seem to add up . . .
Choices are preserved only if customers have the ability to accept those choices without penalty.
In addition, it looks to me like you are only including the “costs” side of the ledger and not the potential benefits to those lenders who can consistently induce customers to switch to their product.
Would there really be greater inefficiencies? You’ll have to convince me, because I don’t see that as being a given. Completely open markets have considerable problems, but efficiency isn’t generally one of them.
Again, if a system is designed so that Customer A has to accept a worse deal so that Customer B down-the-line can get a better deal, then the system is broken.
My negotiations should not hinge on how it will affect someone later, and I don’t accept the premise that this is a logical necessity for rates to stay low.
“If a broker loses his/her ability to use a particular lender, then the next customer suffers and no one wins in the long run.”
Should it not also be pointed out that if a lender restricts a brokers ability to use them, then they also suffer themselves through fewer potential customers.
Frankly, I see the practice as being fairly self-defeating in a truly open market, and I’d suppose that it would not be sustainable.
I think the issue here is that is you have already accepted an offer, and a better one comes along AFTER you accept, then its bad for the broker to switch after the fact. Of course, if the offer has yet to be accepted, then you can go where ever you want. If you COMMIT to buy a car, then find a little better deal somewhere else, you might have to stick with the deal you already have. Same thing with mortgages. Seems pretty logical to me…
This is far too idealistic to work. The broker would have to have a pretty special relationship with the client in order for them to give up money to make the broker look good.
Consumers won’t care about the profit of brokers or others, even if it may benefit the system, and inderectly, them in the long run.
It’s kind of neat to check out the human psychology on the matter : http://en.wikipedia.org/wiki/Prisoner's_dilemma
I don’t think Bob realizes that a mortgage is like any other purchase. If you make a deal you make a deal. Backing out because a better deal comes along later is bad business and penalizes your agent who worked hard to get you the best deal up front.
I think the issue here is that is you have already accepted an offer, and a better one comes along AFTER you accept, then its bad for the broker to switch after the fact.
Oh, sure. If that is what is being talked about I fully agree.
But is that what is being talked about? My reading (which might be mistaken) is that applications are currently just that, and not agreements or contracts (or am I wrong on this), but that Lenders would like them to be treated as such.
Full disclosure: I used a mortgage broker when we bought our house, I like them, I think they provide a valuable service. But this relationship between Lender-Broker seems fairly biased against the consumer.
Raj,
As I said above, if we are talking about contracts then I agree with you completely. But mortgage applications are not contracts — they are applications to see whether a lender will, in fact, grant you a mortgage.
All the “pre-approval” in the World can be given, but they all contain that “unless the Lender finds you unattractive” clause, and until you actually apply, you really don’t know whether or not the lender will give you the money.
A mortgage is a commodity. It’s a “thing” that we need to buy. If one place can afford to sell it cheaper than another place, as a consumer, I would buy it from the cheaper place. We have to assume all other aspects of the mortgage are the same (the best mortgage features for the clients situation and that those features are identical from one lender to the other). If Sears sells iPod’s for $100, and The Bay sells them for $90, I’ll buy from The Bay. Even if I’ve already bought from Sears, I’d return it.
I don’t buy the efficiency argument either. Both lenders had to do their due diligence and approve the deal and verify the supporting documentation. If lender B can do that and still afford to offer a cheaper interest rate, then the consumer should get the better price. Lender A should be given the opportunity to match Lender B’s rate (perhaps before submitting the deal to Lender B?) but if they can’t, then the consumer should get the lower rate offered by Lender B.
And don’t forget, a mortgage commitment is NOT a legally binding contract. It is merely a good indicator that a lender ‘promises’ to release funds on the closing date to enable your home purchase or refinance. Either party (lender or borrower) can back out of the deal prior to closing. The only legally binding contract is the Mortgage Charge (not sure if the legal document carries the same name in all provinces/territories). That’s the document you sign with the lawyer stating you promise to pay the loan back, with interest, and the lender promises to provide the loan.
Having said all that, I do agree that there is benefit in a “gentleman’s handshake” as it were. It does keep all things, and people, ‘happy’ in the system. But I don’t agree that someone should be penalized just in case someone else, at a later date, would be better off.
Interesting post Rob. I’m getting a little tired of hearing about funding ratios, but I was still interested to hear your thoughts.
On the one hand, lenders have a very valid reason to stress funding ratios. Some brokers are guility of not knowing a company’s products before submitting a deal, and that obviously isn’t a good thing.
Saying that, I think there are some lenders who need to settle down a bit about funding ratios. There are lenders who are very, very average (in terms of rates and products offered) who are getting excited about this. I won’t name any names, but we both know they’re out there.
If a lender doesn’t offer anything special and then gets mad at us about funding ratios, why wouldn’t a broker just transfer their business?
Curious to hear everyone’s thoughts on this.
Complaining about the system is terribly short sighted. It is easy to understand why most people will never sympathize with a bank. It’s simply not PC in this country. But a lender’s costs for underwriting an application, hedging rates, and providing support are very real. If they do not enforce closing ratios YOU the consumer WILL pay. And you will probably pay FAR FAR more than the 0.05% number that is being used in these examples.
Susan V.
I’m willing to be convinced. Can you provide me with any specific data to demonstrate this . . . ?
Plus, do you really believe that applications should be treated like contracts?
If Lenders are really concerned about the ratio of applications:contracts, then they should do what every other business does — charge potential consumers an application fee.
When I apply for admission to multiple Universities, I don’t do so with the understanding that my application is an agreement that I will attend. But because Universities charge an application fee (often refundable if I accept the application), I’m not very likely to apply to places that I’m not serious about.
This would seem to be a fairer approach that would not pit Lenders against Brokers and Brokers against their clients.
This doesn’t make sense to me. If another lender is offering the client a lower rate and the broker won’t submit an application to that lender then the client might just call another broker (that will offer them the lower rate). Doing so would cause the broker to loose
the client, the commission, referells from the client while still getting just as negative a result from the bank…
The premise of Bob’s assertion is flawed; and that premise is that your mortgage planner gets you the best rate possible. That is not the case; this is why mortgage lenders now send brokers rate sheets with ranges, for instance the range is between 4.15% up to 4.39% if the broker sells the higher rate to the client he makes more money; conversely he/she can also cut his/her commission to go below the “bottom” of the range. In the end a broker gets you a better deal than your bank but it is a very shrewd customer that can actually get the absolute lowest rate.
Here’s the bottom line:
Mortgage commitments are toilet paper, even after you sign one you can still back out at anytime the lender will not and cannot sue you.
Most people do not give a damm whether the next guy gets a good rate or choice, it’s about this transaction for the individual borrower.
Funding ratios–is not a new practice, just one that many lenders have now realized the merit of enforcing in order to prevent brokers from having 3 other deals in there back pocket at all times and wasting time and money of underwriting staff and support staff, etc.
Non story really, a consumer should cross the street to save one dime, let alone 5 bps, and if one broker is cut off from a lender, who cares many times I can go directly to the lender or there are MANY other brokers available.
“Bottom Line”
With all due respect you are completely ignorant of the repercussions of your statements.
If brokers get cut off from lenders it reduces competition in the marketplace. When that happens there is 100% certainty that EVERYONE getting a mortgage will suffer over time. Do you want to be stuck having just 5 banks to deal with, or paying higher rates because of all the cancellations?
Your point is like saying “I don’t care about littering.”
No, littering may not hurt YOU today, but if everyone did it, we ALL would suffer.
There are thousands of mortgage agents/planners/brokers to choose from if one gets cut off pick another one.
If its a big difference in rate and there is time to change lenders then it makes sense to change.
If it’s a small difference or there is not a lot of time then it doesn’t.
I wouldn’t be surprised if lenders someday make their commitments contractual to deal with people like Bob.
“This doesn’t make sense to me. If another lender is offering the client a lower rate and the broker won’t submit an application to that lender then the client might just call another broker (that will offer them the lower rate).”
If that becomes more of a problem lenders will simply contract out this liability. They will not allow people to profit from being flighty at their expense. When you sign a commitment it means you voluntarily agree to the lenders terms. If you want to waste a lenders time then you will end up paying, one way or another. You can criticize the process all you want, but don’t kid yourself about how serious lenders are about this stuff. Cancellations affect their bottom line and borrowers WILL be held more accountable in the future.
Good topic.
A few final comments.
First of all, the previous “Bob” comment, was not made by me. I made all of the initial “Bobs”, but not the one about just finding another broker.
Second, I take some issue with Susan V’s comment that “Complaining about the system is terribly short sighted.”.
Just because a system is in place doesn’t make it the best system. There is absolutely nothing short-sighted about trying to find alternative systems to meet the same objectives (application fees is one model I proposed, but there are others). What is short-sighted is to simply accept the status-quo just because it exists.
I’ll also object to George’s statement that “If brokers get cut off from lenders it reduces competition in the marketplace.”
I simply don’t believe this is true. Lenders that are too aggressive in cutting out brokers hurt their own business, which presents opportunities for other lenders and other types of brokers to fill voids.
Again, I think the premise that the current system is designed to preserve competition and preserve options for consumers is false. Show me a Mortgage Lender’s business model that includes any indication that they actually want to encourage diversity in the marketplace (i.e., they want more competitors rather than fewer) and I’ll believe it.
Beyond that, I’m afraid I have to assume that Lenders — like all other businesses — are attempting to maximize their profits. And rightly so. I have no problem with this.
I just wish the system didn’t pit the three main players against each other, and I think there are alternative systems that could maintain profitability without doing so.
This is not about restricting profits, it is about ensuring that consumers are able to take the best deal available to them without being punished for doing so — especially without having their own mortgage broker, who is supposed to be working for them quietly restricting options in order to maintain standing with Lenders.
In essence, these sorts of restrictions mean that your Broker no longer works exclusively with your best interests in mind.
If that becomes more of a problem lenders will simply contract out this liability. They will not allow people to profit from being flighty at their expense. When you sign a commitment it means you voluntarily agree to the lenders terms. If you want to waste a lenders time then you will end up paying, one way or another. You can criticize the process all you want, but don’t kid yourself about how serious lenders are about this stuff. Cancellations affect their bottom line and borrowers WILL be held more accountable in the future.
**Not true, lol, more accountable in the future–you think lenders are going to sue everyone that signs a commitment that does not fund? Ridiculous!
They don’t have to sue Bob. The simple act of having a contract would compel compliance through intimidation. This would be true in 99% of all cases. For the 1% that want to test their luck by backing out of a bank contract, good luck to them.
Again, I want to emphasize that I am not the second “Bob”.
“Bob”, why don’t you identify yourself with a name that doesn’t duplicate one already used in the thread . . . ?
They don’t have to sue Bob. The simple act of having a contract would compel compliance through intimidation.
Vince, read a commitment it is not a legal binding contract, hence not enforceable.
Ahhh. Nice sock puppet.
Again, the previous “Bob#1” is a fake.
Administrator — check the IP addresses, we have someone playing games for some reason . . .
Hi Original Bob,
Down the road we will be adding a system that prevents different names from being used with the same IP address in the same thread. But that will take some time to implement. For the time being we’re stuck with TypePad’s system as is. :(