Early Payout Ratios

Early-Payout-Ratios Just when you thought lenders couldn’t come up with any more ratios…

We read this article (click link) in CAAMP’s Mortgage Journal this month.  It talks about how lenders use a variety of metrics to gauge the performance of mortgage brokers.

Two ratios currently in vogue are approval ratios and funding ratios. 

Approval ratios (the percentage of a broker’s applications that get approved) are a useful measure of efficiency.  Brokers with really poor approval ratios take up a lender’s time unnecessarily, and they should be dealt with.

Funding ratios (the percentage of approvals that close) are also based on reasonability—although it’s debatable whether they’re always in the client’s best interests.  Some lenders are also quite unreasonable in their expectations of funding ratios, but that’s another story.

But now, we read about lenders tracking “early payout ratios.”  That’s the percentage of broker-referred mortgages that are terminated by the borrower before their term is up.

The implication is that brokers should be held responsible when clients break their mortgage early—as if we have complete control over it.

It’s true that lenders are best served when borrowers ride out their full term, but penalizing brokers for a client’s decision to refinance (when it wasn’t known in advance to the broker) is ludicrous.

Despite our distaste for this particular measure, there is no disputing the fact that lenders have to make money.  Early payouts affect their ability to do that. 

The story discusses how it takes four years of revenue to pay for all the costs that go into a 5-year fixed mortgage. 

The article also includes this seemingly inconceivable quote: “…all mortgages that pay out early result in a loss for the lender.” 

Wow.  Maybe if lenders are losing this much on early payouts, they should adjust their penalties.  You would think that if a customer chooses a closed mortgage, and breaks his or her contract early, the penalty should be sufficient to bring the lender back to breakeven.

Whatever the case, there are certain lenders out there that are getting a little too ratio-happy.  They should reconsider any and all ratios that penalize brokers for the effects of competition and customer behaviour. 

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Sidebar:  Renewal ratios are yet another broker metric some lenders are tossing around.  There is a quote in the story that states: “Lenders expect to renew 80% of their maturing portfolio of mortgages.” 

Really?  Someone better adjust that statistic because it ain’t gonna happen.  Homeowners today harness the power of the Internet, and the power of choice.  Lender loyalty is not high on their list of concerns. A lender has to earn their business, and the competition is waiting to snatch a lender’s renewing customers faster than you can say “discharge statement.” 

But wait!  How about we claw back brokers’ commissions when a client doesn’t renew!!  Stick it to the broker when the client goes somewhere else for a better deal.  Now that’s brilliant!

  1. Rob, if the lender (the person that gives the money) want’s to track what day the deal funded and what the broker’s favourite colour is, then that is their perogative, a broker who has a high approval ratio and funding ratio would not be cut off by a lender, broker’s should concern themselves with what they can control vs. what the lender is tracking, there money, they can track whatever they like.

  2. It will be interesting to see what if any impact there is on renewal ratios and early payout ratios compared to industry averages for lenders who pay annual trailer fees to brokers. I suspect retention will benefit from this compensation model – but don’t have a guess as to how much.
    The other thing that really frustrates me is that some lenders will offer worse deals to existing customers at renewal or for refinancing than they do to new business. They should be if anything offering preferred rates to repeat business. How about this – every renewal that you make with us, you will receive an additional 5 bps reduction below our regular rates. How is that for showing your existing customers some appreciation?

  3. Condor,
    Thanks for your thoughts. Lenders are our partners and it’s vital that they are profitable and motivated to distribute through the broker channel.
    The issue is not a lender’s right to come up with inventive tracking statistics. They can track blood type if it keeps their number crunchers employed.
    The concern is when:
    A) Brokers are penalized for things they don’t cause (as the story in question insinuates); and when,
    B) Lender ratios make brokers do the wrong things.
    A prime example of the latter is when brokers fail to inform clients with long-term approvals that better deals exist elsewhere–because the broker doesn’t want a cancellation with a lender. (And no, it is not always economically feasible to match a deal from another lender.)
    The point of the above post is simply this. Ratios that impair our ability to properly act on the client’s behalf are bad for the industry long-term. Hopefully lenders balance their drive towards efficiency with brokers’ fiduciary responsibility to the client.
    -rob

  4. How is it fair for the Lender to pay a broker for a 5-yr deal, only to have the same broker move the client in a year or two to another lender and get paid another for another 5-yr deal?? That is what needs to be tracked and those brokers need to be removed.
    Lenders need to make money through this channel as well. If not, and another 1 or 2 big bank lenders exists then this will corrode the entire broker channel and we’ll see more mortgage specialists…

  5. Hi Peter,
    Appreciate the feedback. You raise a fair point and perhaps this is why some lenders are looking at trailer-fee models.
    Whatever the case, who can blame a homeowner for an unexpected change in their circumstances, or for wanting to refinance when rates drop 1-2%?
    No one can expect a broker to advise a homeowner to stay with their lender when it makes no economic sense. Nor should a broker be “removed” for doing what’s best for the client.
    (Mind you, if a client says they’re breaking their mortgage in two years and the broker puts them in a 5-year, THAT broker should be eliminated. But how do you police that while also allowing for legitamate refinances?)
    I am first to admit that I don’t have all the answers, but there’s got to be a way to better address the client’s, broker’s and lender’s interests fairly. Having a dialog is the first step and is the reason we put these issues out there.
    Cheers,
    -rob

  6. CMT: “Ratios that impair our ability to properly act on the client’s behalf are bad for the industry long-term. Hopefully lenders balance their drive towards efficiency with brokers’ fiduciary responsibility to the client.”
    I have nothing against brokers, so don’t read this negatively, but the fact that brokers are paid by the lender versus the consumer means that your fiduciary responsibility is already ‘corrupted’. Perhaps if there was a flat fee (i.e. a standard rate paid the same by all lenders to all brokers) then brokers could be seen as completely impartial. But if it comes down to a court of law, a person works for the person who pays them.
    I do want to say that I generally agree with the argument being stated in the story, brokers often have very little influence over what happens once a mortgage funds. Sooooooo much can happen in a persons life that could cause an early renewal, and the broker has no control of that. I suppose there could be a disclosure of some kind to ‘warn’ a borrower who signs for a mortgage longer than 6 months or 1 year, but a broker probably shouldn’t be penalized if it does happen.
    I agree with others, if the lender truly values their current clients and expects them to stay, they need to be just as competitive with them as they are with new business.

  7. The Golden Rule:
    He that holds the gold sets the rules.
    Rob, you are biased in this argument, you are a broker, you work for the lender not the client, I realize you look out for the client, etc. But you also look at who is paying the best finder fees, best volume bonus, etc. And I am not saying this as a bad thing just fact, that you are biased in many of the arguments on this page.

  8. Karen,
    Perhaps you’re not familiar with our business model. :)
    We refer 30-40% of clients to lenders who don’t even pay us. (RBC, BMO, HSBC, Canadian Tire, Meridien CU, AMA Financial, etc. etc.)
    We do that whenever we feel it’s in the client’s best interests.
    I don’t want to sound holier than thou, but we work for the people who trust us to do what’s right for them. It’s just how we operate.
    In a perfect world lenders would do what Rob suggests above: pay a flat fee and throw conflict-of-interest status programs right out the window.
    Alternatively, we’d love a system whereby a broker could charge a small up-front consultation fee, and rebate it back to clients at closing. That way the broker has immediate economic incentive to recommend the best option. Unfortunately, my understanding is that regulators don’t allow up front consulting fees in most cases. I think that’s unfortunate because it’s a model that works well in other trust-based industries.
    Despite all this, I think it’s important to remember that there are thousands of good and decent mortgage planners in our industry. These are people who make honest recommendations to clients despite their compensation. We are far from the only ones with customer-centric business models.
    Hopefully this clarifies where we’re coming from.
    -rob

  9. This is one of the best debates I’ve seen on this site. CMT is a valuable resource and I hope you (Melanie and Rob) continue your excellent work.
    JT

  10. “How is it fair for the Lender to pay a broker for a 5-yr deal, only to have the same broker move the client in a year or two to another lender and get paid another for another 5-yr deal??”
    Umm, have we forgotten about prepayment penalty’s? If the lender charges the client 30K to break their mortgage early, is this such a hardship for the lender? I wouldn’t be surprised if the lender made MORE money off of early payouts then if the loans went to term…
    frankly, I’m put off by lender with these types of completion ‘ratios’
    don’t want my clients business? no problem, we will go somewhere that does. I think it would be pretty hard for a lender to make any money with no one to lend too…

  11. Blair, many lenders do not bother with broker business and do quite well, seeing less delinquincies and less fraud, that’s a debate for another post. As for your comment if the customer pays the penalty the lender has no issue, it’s when the customer moves after the 5 year term, because the broker wants to get another finder fee–is it in the customer’s best interest to move the client, we all know that the client 95% of the time can get the same rate if they just stayed where they were, hence the topic of trailer fees has entered the conversation. Brokers moving customer’s around is a joke, they state to the customer I can get you a better rate elsewhere–just to get paid, as stated MAJORITY of the time they can get the same rate without moving the mortgage.

  12. Stan,
    You make multiple misleading statements.
    First, there is no significant increase in deliquencies and fraud with broker business. It is also not uncommon for lenders without a broker division to lose market share. BMO is the most notable example.
    Second, that 95% figure is patently false. If a client could get the best deal with their current lender they would not come to brokers asking for something better.
    Third, lenders want renewals but they don’t offer their best deals to existing customers. You can’t have your cake and eat it too.

  13. Jim,
    You make multiple rebuttals with no basis.
    BMO chose to leave broker business as delinquincies were up and the quality of business from the broker channel was deteriorating, all lenders that deal in broker business realize the nature of the beast i.e. certain brokers fabricate, doctor documents, etc, it is built into risk models.
    Second, the 95% figure is correct, unfortunately many consumers do not know that they could get the same deal if they stayed with their existing lender, assuming the existing lender would want to retain.
    Thirdly, you do not think there is an issue with brokers moving there book around town at renewal? If you do not see that as an issue then go back and put you head back in the sand.

  14. I’m surprised that all of the commentators in this thread, along with the recent cheesy Caamp article, missed or skipped over a huge fact.
    In the case of IRD penalties, the lender collects the yield for the remaining term of that mortgage in one swoop. No more admin costs, and the lender in turn re-lends it out again and begins earning income once again on those funds.
    In IRD markets, lenders can do this all day long and increase their earnings. Big hole in the caamp article, but not surprising.

  15. Hi TB,
    Thanks for the note. I was tempted to comment on the IRD as well, but felt it difficult to make a blanket statement on how lenders gain from it–as it can vary from lender to lender.
    Nonetheless, the IRD is indeed a noteable point. I’d like to see a lender comment on the extent to which IRD addresses their early termination losses.
    Of course, when rates are rising, they no longer receive the IRD….
    -rob

  16. It was in my post above:
    Blair, many lenders do not bother with broker business and do quite well, seeing less delinquincies and less fraud, that’s a debate for another post. As for your comment if the customer pays the penalty the lender has no issue, it’s when the customer moves after the 5 year term that is the issue.

  17. Banks may lose money from clients if they move there mortgage pre-maturely however, what about all the cross selling they are doing in the meantime. Credit cards at interest rates of 15+percent, rrsp investment possibilities, bank fees (chequeing accounts…) personal loans…If it were not for brokers they would not even have a chance for that business.
    Another point. I’m not saying all brokers are on the up and up but do you think all bank branch employees are? You think they don’t commit fraud and doctor documents. It’s much easier for them as most have lending limits and can approve things on their discretion where brokers have to go through at least one other person.
    Lastly, if banks want to retain the clients and are looking out for their best interest why is it that they don’t contact the clients when it’s advantageous to break their mortgage to get a new rate?
    Just food for thought.
    PB

  18. @Stan – I’m still on my first mortgage, so I haven’t had to go through a renewal yet, but if many lenders behave like they do at the outset, then it’s not surprising that people switch lenders. If my current lender tries to play games at renewal time (i.e. offers me anything other that their best rate), expecting me to barter back and forth like in a middle eastern bazaar, I’ll be finding lenders elsewhere.
    At that time, all else being equal, if they aren’t able to BEAT the lowest rate I can find, they’ll be losing my business.
    As posterboy notes, lenders should be just as competitive with their existing clients as they are when they’re trying to get new ones. If it truly does cost a bunch of money to land a new client, you’d think they’d be paying MORE attention to existing clients.
    My $0.02.
    Al R

  19. Lenders losing money?? Thats a laugh. With those ridiculously high penalties we are forced to pay if we’re unlucky enough to be locked into a long term mortgage at a high rate, how on earth can they be losing money?? I’d have to pay the Lender $16,000 to re-finance my 5.65% 5 year mortgage (with 3.5 yrs remaining) just to try and get a bit lower rate. I feel as if I’ve been robbed blind by the Lenders out there. Its the customers who are losing money and LOTS of it, not the Lenders who just make more and more out of every transaction, not to mention the penalties they sneak into the contracts.

  20. Hate to play Devil’s advocate here, but it you sign a contract with parameters that are clearly laid out, you can’t cry foul when it turns out that you would have gotten a better deal going variable or taking a shorter term.
    If you were happy paying 5.65% for a 5yr fixed a year and a half ago, it’s not like you’re paying any more today because rates have gone down.
    Ergo, these consumers aren’t “losing money”, they’re just not able take advantage of historically low rates, because they wanted zero risk (perhaps appropriately so in some cases) and went fixed over variable. By doing so, they forfeited any chance at benefiting from lower rates in exchange for cost certainty.
    Al R

  21. I just broke and moved my mortgage and I know my bank took a writedown. They played games with me after I told them I was going to pay the IRD and move. When I was ready for the move they did indeed match the new lender but as the new lender was paying the moving costs (fees to move), and everything else was equal, I moved.
    It gave me a great feeling that I cost my bank money because they treated me badly.
    This website suggested that I make my prepayments just before I break to reduce the break fee and I did that. Fortunately, the anniversary date was in May so I was able to make TWO prepayments at the same time knocking my IRD down considerably. IRD is based on a number of variables so not all are going to be high.
    When I look back on negotiating mortages in the past I see how the banks have again and again pretended they were “advising” me when they were really directing me with their best interest in mind.
    The only way to win is to educate yourself and this website does a fantastic job of making it easy.

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