Pennying the Mortgage Competition

pennying-mortgage-ratesIn the stock market, “pennying” (a.k.a. penny jumping) happens all the time.

Pennying is when a seller offers shares one cent below a competing seller in order to undercut them (and vice versa when buying).

The equivalent in the mortgage business is pricing under a rival lender or broker by one basis point. (A basis point = 1/100th of a percentage point.)

Lenders and brokers penny each other because they know that the lowest rate often generates the most inquiries. An example from this week is First Ontario’s new 4-year promo priced at 2.98%, one basis point below the big banks’ 2.99%.

This pricing relies on the same psychology that motivates people to drive two kilometres to save two cents a litre on gas. The difference is: Gas is a pure commodity. Not so with mortgage services.

Pennying in the mortgage market is nothing new, but it’s getting more frequent. It will continue to get more frequent as brokers and lenders try to position themselves ahead of online competitors.

As a homeowner sizing up the best deal, a lower rate is instinctively enticing. But the difference becomes less compelling when you fire up a calculator. The cost differential between 2.99% and 2.98% is 52 cents a month for every $100,000 of mortgage. The average mortgage is $151,000 so that “penny” saves the typical mortgage holder $9.24 a year.

You’d think that most folks would never entrust one professional over another with their biggest liability, just to save $9 a year. But it happens surprisingly often. For some folks, saving a basis point is like saving their little toe from amputation.

And God bless them. Who doesn’t like a good deal, right?

But of all the things that should sway someone when picking a mortgage, 1/100th of a percent is not one of them. The mortgage process entails continuous decisions (decisions on product options, application structuring, balancing rate with restrictions, term selection, prepayment strategies, etc.). There’s ample opportunity to overlook subtle details that can add hundreds or thousands of dollars to borrowing costs.

One way to minimize that risk is by finding a mortgage adviser who:

And of course, once you find someone like this, you should still expect them to get you a fantastic mortgage rate for the features, advice and service level you desire.

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The tip we’d depart with is this: When evaluating a great mortgage deal, compare each alternative within 10-15 basis points of the lowest rate (i.e., within $12-18 a month on a typical mortgage). Then, look at the adviser you’ll be working with to get that deal. Ask what else they bring to the party besides a few basis points in rate savings.

Nine years ago (before we were in the mortgage business) we learned something the hard way. We picked a mortgage with the lowest rate without knowing exactly how our penalty was calculated. When we broke it early, it cost us thousands versus what we could have paid a dozen other lenders.

There are certainly few areas of life where being penny wise and pound foolish can hurt as much as it does in the mortgage game.


Rob McLister, CMT

  1. As a long practicing broker, I hate to admit the pricing activity going on in the market today is the fiercest it has ever been. While your comments in regards to traits to look out for in a mortgage adviser are spot on, borrowers are learning that good advice received by a true mortgage professional is even better when put into practice with a low(er) interest rate. Unfortunately, 10-15 basis point spreads on comparisons is too wide a margin in this market…5bps is more appropriate. Pricing policies of banks like BMO, or some of the brokerage houses matching BMO’s current 5 year offering, have done nothing more but underscore the fact that mortgages, like any other consumer good/service has become a commodity (like milk, bread, eggs, and gas)…given the choice, the consumer will usually go with cheaper, rather than better. It really pains me to admit this.

  2. Hi tdavino,
    Thanks for the post! When it comes to rates, it’s the lower the better, but only if all else is equal. The reality is, the most suitable product for a given client is often unavailable at the lowest absolute rate, and seldom available within five basis points of the bottom (hence the 10-15 bps reference…).
    If one only looks at options within five basis points of the low, it often excludes features that matter. BMO’s 2.99% 5yr rate promo was a perfect example. For a short period of time there were no good widely available 5yr terms within five basis points—assuming one wanted an unrestricted term, normal prepayments, an amortization over 25 years, a readvanceable credit line, etc. It was also hard to find quality independent mortgage advice at that rate.
    Even though mortgages are increasingly commoditized (we’ve been talking about that for a few years), professional counsel is still far from a commodity. Whether folks realize it or not is another matter. There is a never-ending stream of clients who are given bad advice by an “adviser” they trusted. High-volume mortgage professionals come across such cases daily or weekly. For now, knowledge and experience are still at a premium, until someone successfully digitizes them. :)
    As you suggest, most cannot quantify the benefit of dealing with a mortgage professional who meets the criteria in this story. And that’s the biggest challenge our industry faces.
    Cheers…
    Rob

  3. Thank you, Rob, for the great articles!
    I agree 0.01% difference is meaningless but 10-15 point difference will likely sway borrowers towards the cheaper rate since it translates to roughly $500-750 difference on an average $150k mortgage over the 5-year term and the better terms of the more expensive mortgage may look like unnecessary features they will unlikely to use or insurance.
    And how one can recognize whether the adviser is good or bad? When you first start dealing with someone the soft people skills of the professional play a big role. If that person is “nice” and “friendly” and seems to be a “good guy” you will likely use their services. But only after doing the business with that professional for some time most (but not all) customers will understand if they have been getting a good service and their advisor is a real treasure or the opposite or just OK.

  4. Rob,
    those of us in the industry speak about our value proposition etc., being vital to a consumer’s overall mortgage planning. However, those are the same brokers & agents advertising on the rate shopper websites (I’m sure we all know the names of these sites) for that 1bps lower just to get the business.
    To quote Seth Godin on an interview I saw recently “its a race to the bottom and, guess what? you might win”
    if we want to improve the industry and raise the profile of broker/agents value to the consumer, then we must remove ourselves from the very problem we’re complaining about. Call to all brokers & agents – stop advertising on the sites..please!!

  5. A broker in Halifax was quoted in the newspaper last week as having advised a client to pay a $16,000 penalty to refinance, even though the interest savings would only be $16,000 – just so they could secure their rate for the next 5 years. So this homeowner either erased hard earned equity or put a significant dent in their savings. Any idea what the broker’s payday would be on this deal? This homeowner could have gone to their current lender and blended their rate with no penalty; financially the exact same result – without spending $16k. But of course the broker wouldn’t get paid for THAT advice.

  6. 16k…..wow…gee i dont feel so bad now when i paid a four grand penalty to drop from my fixed into a variable way back when

  7. it was great advice from my mortgage broker who sd the variable was a bargooon and would probably stay a bargoon for a long time to come….hmmm…maybe hes a relative of carney…..but i’m sure my friendly neighbourhood banker would have given me the same advice….not!

  8. What you said is inaccurate. Blends are always have a higher interest rate. The lender simply incorporates the penalty into the rate so you don’t pay it out of pocket. But you still pay the penalty.
    What that broker advised makes perfect sense if the client wants to extend the term. Doing that could save much more than $16,000 if rates go up as expected.

  9. yea my banker said dont go with the variable its too much like gambling….go with something solid…sure the rate is 3 pts higher but u will have security for the next five years…yea rite…but damn, i wld like to get this mullet trimmed back a bit

  10. 5 years ago a good advisor at a big bank (TD) told me to go with the variable because the rates were likely to go down. He also matched, not without some haggling, the best advertised rate of Prime-0.9%. I had been researching the mortgage rates and economy for some time back then and agreed with his assessment. The rates did go up 25 points for a bit but after that were constantly falling until my mortgage rate went down to a laughable 1.35%. The banks could not let that happen and jacked up the prime.
    My point is that not all bankers are that bad even in the big banks.

  11. Thanks tcm1,
    The only time it makes sense to pay more for a mortgage is when one gets more value in return.
    The advice to evaluate alternatives within 10-15 basis points means simply this: Consider mortgages that cost more, only if they have more functionality, fewer restrictions and/or an adviser who adds genuine value….and only if you can take advantage of those things.
    If you can, the savings can be many multiples of 10-15 basis points.
    You’re totally right that it’s sometimes hard to judge a mortgage professional’s competency if you don’t know the person. To address this, people can research comments on brokers online, ask the right questions (we’ve written about that on CMT), or get a referral from someone they trust.
    Cheers…
    Rob

  12. Hi RTB,
    Thanks for posting. Helping consumers understand the role of proper mortgage planning is essential. At the same time, the trend today is for greater competition and transparency. That’s made rate aggregation sites increasingly popular and eventually they’ll become ubiquitous.
    The good news for consumers is that rate shopping sites are pushing rates down industry-wide. The downside is that they’re encouraging folks to focus more on rate and less on what really matters: total borrowing cost.
    Discouraging brokers from contributing to rate aggregators likely won’t work because brokers will refuse to give up the leads. Finding more effective ways to reach and educate borrowers is probably the better approach.

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