Be Loyal & Don’t Shop: A Recipe for Overpaying

mortgage-shoppingBig banks love mortgage consumers who don’t carefully comparison shop.

They also enjoy capitalizing on their “home bank” advantage with existing customers.

The article that follows examines recently-released research on these topics. It’s a revealing look at how big lenders benefit significantly from things like mortgage “search costs” and customer “switching costs.”

“Search costs” refer to the time, skill, money and effort required to find a better mortgage deal. “Switching costs” represent the expense of moving to a new lender.

The findings below come from a brilliant Bank of Canada research paper by Jason Allen, Robert Clark and Jean-François Houde. It’s chock full of insights into why mortgage consumers pay higher rates than they have to, and why being loyal to a lender can cost you.

The key findings of this research are summarized below. If you don’t have time to read them all, focus on the highlighted parts. CMT comments appear in italicized text and after the “Observations” labels. All quotes are taken directly from the study.

Consumers aren’t created equal:

  • Research shows that there are major differences in people’s:
    • “Degree of loyalty to their main financial institution.”
    • Ability to “understand the subtleties of financial contracts”
    • Ability and willingness to “negotiate and search for multiple quotes”
  • Canadians generally don’t consider all available mortgage alternatives.

Hunting for a better mortgage:

  • Picking-a-mortgage-BlindMany borrowers simply do not work as hard to “search” for a better mortgage. That’s largely because of the effort they “must put forth when gathering multiple quotes.”
  • Inadequate mortgage research induces “profits for lenders” and “permit(s) them to price discriminate between consumers.” (It also raises your chances of getting stuck with bad mortgage terms.)
  • The average markup is estimated to be 4.1% for non-searchers and 1.9% for searchers, but the distribution is much more skewed for searchers with close to 25% of [comparison shoppers] facing zero markup (above the marginal cost).”
  • In the past, “approximately 25% of borrowers [paid] the posted rate.” (This was based on data from more than a decade ago. The numbers are not as high now, especially for well-qualified borrowers. That said, there is no data to confirm how many people actually pay the posted rate today.)
  • “…Consumers dealing with [large] institutions pay more on average for their mortgage.”
  • Not surprisingly, the decision to switch lenders is “correlated with” the borrower’s willingness and ability to search for a better deal.
  • “The fraction of ‘switchers’ is significantly larger” for:
    • New homebuyers (i.e., former renters or [those] living with their parents), and for
    • Broker customers (Lenders love to get their hands on first-time buyers, and it’s a big reason many are happy to pay brokers to deliver those customers.)
  • “Consumers financing larger loans…are more likely to search (and pay lower rates).” In turn, they have a higher “switching probability.”
  • “Richer households have a higher value of time, and therefore higher search costs on average.” (…and many of them needlessly overpay.) In short, they have less tendency to switch lenders.
  • “…About 30% of consumers only consider dominant lenders.” (Usually a big mistake.) “For these consumers, the average number of lenders drops to three, which can significantly increase the profit margin of banks.”

“Home Bank” advantage:

  • bank-tacticsEverything else equal, a customer’s home bank usually gets their mortgage business. This is akin to a home field advantage in sports. (“Home bank” can also refer to a client’s “home lender.”)
  • Even when all is not equal, the home bank often wins. That’s partly because consumers are “motivated by more than just price.”
  • The study’s authors estimate that consumers are willing to pay “between $759 and $1,617 upfront ($13.80-$29.40 per month) to avoid having to switch banks.” (Many will pay more because they can’t quantify the value of lender differences. Case in point are mortgage penalties, which most people can’t measure until it’s too late—when they have no choice but to break their mortgage and pay whatever they’re quoted.)
  • Put another way, “lenders directly competing with [a client’s] home-bank will on average have to discount the [mortgage] by a margin equal to the switching cost in order to attract” a new customer.
  • The study finds that “loyal consumers pay on average nearly 9 basis points above the rate paid by switchers.” (It’s no coincidence that many borrowers choose to stay with their existing lender when a competitor’s rate is better by less than 10 basis points.)
  • Not surprisingly, “the market for ‘non-loyal’ consumers is very competitive”
  • Factors that support customer loyalty to their home bank include:
    • Proximity to a local branch
    • Better access to lending terms
    • Association with a strong recognizable brand
    • Consolidation of accounts (for convenience)
    • Lower chequing account fees, higher savings rates and other perks (Bank and credit union reps commonly use these perks to counter customer objections to higher mortgage rates. To some extent, free banking, banking comparison sites and modern-day electronic funds transfers are reducing the allure of these home lender “freebies.”)
    • The cost and effort of switching bank accounts to a new lender (It isn’t necessary to have your mortgage and bank accounts at the same lender, but some people believe it’s important.)
  • Cut-Mortgage-RatesObservation: The data used in this study is 11-13 years old. There is no way to know how much the home lender advantage has changed in that time. Various factors have altered this advantage over the last decade, including:
    • Rate comparison sites — which make it easier to know when your lender isn’t being competitive
    • More broker competition — Brokers reduce consumers’ search costs by assisting them with comparison shopping and offering comprehensive advice not biased to one lender. (Although, it should be noted that in most cases 90% of a broker’s volume is routed to three lenders, so there can be bias there as well.) “Unlike in the United States, brokers in Canada have fiduciary duties…The average discount that a mortgage broker can obtain for a borrower is about 20 basis points, or approximately $16 per month on a $140,000 loan.” (It’s likely lower now as this data is old.)
    • Electronic banking — Many consumers want a mortgage that’s integrated with their banking. That plays right into the hands of deposit-taking lenders. Today, however, one can link different institutions’ mortgage accounts and bank accounts and electronically move funds between them with ease.
  • “In 2004, 80% of new borrowers…contacted their main financial institution when shopping for their mortgage.”
  • The research shows that, depending on the year, “nearly 60% of new home-buyers remained loyal to their main institution.” (CMHC’s Mortgage Consumer Survey finds that 88% of renewers remain loyal to their existing lender.)
  • “…Only 35% of consumers dealing with brokers remain loyal to their home institution
  • 73% of households choose a lender with which they already have a prior financial relationship. The study authors estimate that “72% of consumers have a positive home (bank) bias.”
  • “67% of Canadian households have their mortgage at the same financial institution as their main checking account.” (Having your bank account gives a bank an enormous advantage. Some have even been known to scan customer chequing accounts to see if they’re making a mortgage payment to another lender. The bank then contacts them ”out of the blue” to solicit their mortgage business.)
  • Banks are more likely to transact with customers who are not motivated to search as hard. (These customers are low-hanging fruit for the banks.)

Home bank tactics:

  • Bank_Status“Lenders…are open to haggling with consumers based on their outside options.” (We all know that, right?)
  • “This practice allows the home bank to price discriminate by offering up to two quotes to the same consumer: (i) an initial quote, and (ii) a competitive quote if the first one is rejected.” (Savvy well-qualified consumers routinely reject their lender’s first quote.)
  • Lenders know that “low risk and wealthy consumers represent lower lending costs.” For that reason, lenders offer “lower rates on average” to these borrowers.
  • “The loan sizes and credit scores of consumers are particularly strong predictors” of the rates they pay.
  • Lenders know financially constrained consumers have fewer options. These people “pay on average a premium equal to 14 basis points.”

Stats of note:

  • At the time of this study, the “Big 8” (Bank of Montreal, Bank of Nova Scotia, National Bank, Canadian Imperial Bank of Commerce, Royal Bank, TD Canada Trust, Desjardins and ATB Financial collectively “controlled 90% of assets in the banking industry.”
  • “Interest and fees generated from mortgages represent approximately 21% of total revenue for the largest banks.”
  • “80% of new homebuyers require mortgage insurance.”
  • This is the distribution of mortgages between a client’s main and secondary financial institutions:
Account Main FI 2nd FI All other FIs
Mortgage (all) 67.4% 10.9% 21.7%
Mortgage (no broker) 70.3% 10.8% 18.9%
Mortgage (broker) 37.3% 30.6% 32.1%

Source: Canadian Finance Monitor survey conducted by Ipsos-Reid, between 1999 and 2007.

  • “On average, borrowers pre-pay an additional 1% of their mortgage every year.”
  • “Richer households are more likely to pre-pay their mortgage, which reduces the expected revenue for lenders.”
  • “The (mortgage) transaction rate is on average 1.2 percentage points above the 5-year bond rate” but varies widely.”
  • “The standard-deviation of retail (mortgage) margins is equal to 66 basis points.”
  • At the time of the study, “80% of consumers transacted with a bank that has a branch within 2 kilometres of their new house” (In the electronic banking age, lender location has taken on less importance. Tens of thousands of customers now choose lenders located nowhere near their home—often in a totally different province.)
  • Here’s an interesting finding from the U.S.: “Hall and Woodward (2010) calculate that a U.S. homebuyer could save an average of $900 on origination fees by requesting quotes from two brokers rather than one.”

Miscellaneous Findings:

  • rates-mortgagesIt is “unlikely that the posted rate is used to attract new customers,” say the authors.
  • But why are posted rates still in existence? Well, the report states: “Banks have an incentive to post an artificially high interest rate that is not binding. Indeed, the pre-payment penalty is…evaluated at the posted rate valid at the signature date, rather than the (actual) transaction interest rate. Banks therefore have an incentive to raise the posted rate, in order to reduce their pre-payment risk.” (Many discount lenders—particularly broker-only lenders—don’t play these penalty games. They base your penalty on the actual rate you pay, which is much more fair than the big banks’ method of using posted rates.)
  • “…Lenders can incur transaction costs in the event of default, therefore lowering the expected revenue from risky borrowers.” When a borrower defaults, lenders also face “lost revenue from complimentary products like other loans and saving accounts.” Hence, contrary to charges by many housing critics, mortgage insurance does not eliminate a lender’s risk. (For more on this see: Skin in the Game)

Implications of this data

cost-comparisonThose of us who see borrowers overpaying on a regular basis know how important it is to compare mortgages options. But it’s interesting to hear the repercussions of not doing so, as articulated by a reputable academic source.

These findings should stick in regulators’ minds, especially as they contemplate policies that:

  • discourage price discrimination
  • support greater access to funding (via securitization) to promote lender competition.

Allen, Clark and Houde note that “policies designed to increase information about the market, (mortgage) contracts, or the availability of different lenders would be beneficial to consumers.” A good example of this is the Department of Finance’s penalty disclosure initiative—for which it deserves big applause.

Similarly, the authors conclude: “policies that encourage consumers to consider lenders other than their main financial institutions would reduce overall market power.”

About the Data: It’s important to note that this study’s data was comprised only of high-ratio insured mortgages arranged in branches between 1999 and 2001; It did not include brokered mortgages, very big or very small mortgages, applicants with extremely high or extremely low incomes, or conventional (uninsured) mortgages.

If you’re interested in more research about mortgage pricing, see: Getting the Best Mortgage Rate.

Rob McLister, CMT

  1. Rob, Wow. Lots of info here but very informative! My personal opinion is that everyone should talk to a broker, even if they are leaning towards their existing bank. You don’t know what you don’t know until you talk to an independent mortgage professional.
    Have a great day!

  2. “About 30% of consumers only consider dominant lenders…For these consumers, the average number of lenders drops to three”
    What is so great about a dominant lender? What IS a dominant lender anyway? Dominant to me is the best rate and conditions. Period. Size isn’t everything.

  3. The key is “should”. Most first time immigrant buyers would go for a BIG BANK.
    The intelligent portion of the buyers will never go twice with a big bank unless it matches the best broker offer.
    I’m glad sites like this one exist to educate people.

  4. Now days rates at big banks are way better than most broker/lender rates, so why going to a lender when you can get the same deal or better at your bank. Couple of years ago mortgage broker had the rate advantage, but now that banks are willing to compete, I don’t know why I would get my mortgage from a unknown lender like “street capital” for example than going to my bank.

  5. Big Bank: Have to disagree with you. Why would I get a client a mortgage through a bank when I can get them one through a smaller lender for a lower rate and with all the perks? The best 5 year I can offer a client through a big bank is 3.19% but I can offer them 2.94% from our company. Why would you not take the 2.94%?
    And speaking of the “unknown” Street Capital. The best 3 year I can offer a client from a big bank is 3.10 – 3.19%% but I can offer them 2.69% from Street. These are examples of how clients can save money on their mortgage payments by talking with their local friendly mortgage agent rather than a big bank.
    By the way big bank, your comments would have validity if you backed them up with actual numbers rather than making ludicrous inaccurate comments about mortgage agents.

  6. The reality today is if you are well qualified, happy with your Home Bank and current mortgage, it’s easy to research what is a good rate and then approach your lender of choice and ask for a match.
    This also extends to current Prime+1% HELOC’s. The minute I heard that RBC were promoting Prime+0.5% HELOC’S, I walked into the bank currently holding my HELOC and successfully demanded a match.

  7. The fact is, it’s not always just about pricing, however, it is always the main focus. I have heard lots of stories about dealing with brokers and I am not saying brokers are bad, but sometimes the lenders that brokers match their clients with are not so hot. I always tell my clients to read the fine print. For example some brokers charge a finders fee from $2000 to as high as $5000 I have heard, just for running the application. Also when dealing with a smaller lender you are always having to call the 1 800 number to get any service on your mortgage, which means listening to elevator music for anywhere between 10-20 minutes. Then getting someone that doesn’t know the answer who says that they will call you back and never do. But maybe you are lucky enough to get some knowledgeable and you ask then to make a change to your mortgage. Perhaps switch from monthly to bi-weekly. Well if they can even offer that service, they will most likely charge the client a service fee in the range of $150. And what if you want to pay down your mortgage faster, with a lump sum or increasing your regular payments. Again something you may not be entitled to when dealing with some of these smaller lenders. And who knows who will own your mortgage 6 months from now with a small lender. They are getting bought out and some are just out right shutting the doors like Firstline mtgs. So yeah if you only want to focus on rate, brokers may always have an advantage. But the fact is brokers flash that rate so big that clients are not able to see all the small print that they are going to get caught up in later. And when you have trouble, and call your broker, what will they do? They will instruct you to call the lender as they cannot do anything for you, aside selling you another rate. The big banks do not always pride themselves on the best rate. However, we do provide the best advice, service and flexibility in our products. And we know it’s a competitive market, so we are always listening to our clients and doing everything we can to earn their business. Do you ever wonder why someone chooses to buy the BMW vs. KIA? Some may say status and prestige, which I will agree. But the biggest reason is they know they are getting quality and might pay a little more for that luxury and/or piece of mind.

  8. People should only go to a BIG BANK if offers better deal than a broker.
    Not just the Rate is important, the Conditions count as well.

  9. I would never shop for a MTG without consulting both channels, broker and bank.
    While the “broker will shop for your best rate” mantra is generally true, so is the flipside of the equation, a broker will sometimes shop for “their” best deal
    In my time in the industry the worst examples of mortage advice I have ever witnessed have been generated by brokers who are incentivized to complete a deal regardless if its in the best interest of their clients.
    Not trying to slag brokers who can provide fantastic value to their clients, but if we are going to contiually bang the gong on brokers shopping for best rate I think their needs to be discussion around the downside of just getting advice from one channel

  10. I must say BBJ you completely absorbed your big bank training course. You have hit every single point your trainer spent hours droning on about.
    Mortgage brokers have to listen to this drivel everyday. I won’t address all the points because every single one of them are utterly false.
    Many are just laughable: “charging you a $5000.00 fee in the fine print” wow, now that is a real whopper.
    BMW versus KIA, boy that is just wild. Its a loan……….. a loan, not a car or a house or a suit. There’s a interest rate and contract provisions, that’s it. Nothing more. Read the contract and make sure you are happy with the conditions, get the best rate you can and you’re done.
    The extra crazy part is suggesting big banks have wonderful call centres. Oh boy, that is actually falling done funny.

  11. Banks today like to go on and on about how much they have changed, better mortgage rates more friendly service etc etc…well, boys, I’m from Missouri…prove it and none of these nice low mortgage rates til, oh, about 3.30 this afternoon and then rates up again…just look at rbc with their mortgage rates down then up, then down, then up….uh boys the economy is still in the crapper and probably will be for a bit

  12. “Now days rates at big banks are way better than most broker/lender rates”
    That is an outright lie.
    P.S. Street Capital is a publicly traded $10 billion lender. Not exactly unknown.

  13. I am sure Ivory Tower knows how to read conditions and he is right.
    If the conditions match, go back to your exisitng lender and get the same deal.
    This is the reality of the information age, it’s easy to find out what the best deal is.
    You can’t fight the future.

  14. As Ron Butler has said -what a response.
    Three points: Re: smaller lenders being taken over. First Line did indeed shut its door to the broker channel. FYI First Line was owned by CIBC so they have absorbed all those mortgages.
    No client is charged an upfront fee for an application. (FYI – Against Ontario law).The only time when a client is charged a fee is when “B” lenders or private lenders are used.(Privates do not pay finder fees). These are credit challenged clients that big bank Sr and Jr would not even look at. We are able to get a mortgage for them, save their home and this allows them time to rebuild their credit and eventually get back into a regular mortgage. The clients do NOT blindly sign a contract like this until ALL the fine print is disclosed to the client.
    Three: In any mortgage commitment the client has the choice to select the type of payments they want. They are made fully aware of what type of lump sum payments they can make.
    Don’t believe everything you hear, just believe it when you see it on a signed contract.

  15. I disagree. People should go where their needs are best served. For some that’s the big bank, little bank, virtual bank, broker, C.U. or mom and dad.

  16. As someone who has worked for two of the big banks , and gone back to the brokering world.I have worked in the mortgage industry for over 20 years , as an employee of either of the big banks I was encouraged to sell mortgages that would generate the most profitability for the bank. I was only able to sell one product even if it was not a good fit for the client. I could not sell what I did not believe in so I came back to brokering. I have helped many clients who went to their banks and were completely miss informed by someone with very little mortgage experience at the bank level. They did not even run a credit bureau when they gave their client a pre approval !!! As a broker I can pick the lender and product that is best suited to my clients and in their best interest. I Never have charged an upfront fee. I am available 24/7 is your bank ? Why do you have to shop for the best rate and then take back to your bank to match ? I will give you the best deal when you walk into my office. If your bank is really taking care of you why do they send you a mortgage renewal with the posted rates and expect you to sign it when the market rates are much lower ? The best decision should be an educated decision !!!

  17. If you are well versed in mortgage-ese and know every lender’s conditions then your match strategy is fine. Very few people meet this description. In fact I’d bet that 99% of people can’t find the best mortgage on their own. They can find something close to the best but there is always that one little difference that costs you. You’re better off using a trustworthy broker (or two) and letting them handle the comparison shopping and hassle.

  18. It’s all about perception, you say. But the best financial choice is not always the one you feel happy about.
    Banks rely on “happiness seekers” for most of their business. This is in process of changing with the help of brokers and sites like this one.
    Most of my friends and friends of friends also know what the best financial choice is ind it isn’t “loving your BIG BANK” :)

  19. Dear Banker,
    Wow, you just amaze me with your knowledge about mortgage brokers (the real ones with gov. licenses)
    You must also read lots of Communism propaganda about Banks borrowing money to the public or Disney stores. Remember one thing, the Bank only helps you when it’s going to make money on you, not otherwise. About your cars, now days in many models KIA is biting BMW with safety and performance. For BMW you have to pay twice more because name, same as the Bank name, so go ahead. This is your money and your future, if you want to overpay thousands of dollars for your mortgage, it’s your choice. How do you think Bank is making billion of $$$ every quarter of the year? Shame on you to give false opinion of a group of hard working people. No one is perfect and Bank mistakes are a lot more common than ours, so if you are so smart don’t look over the fence, try to dig hole in your garden first and you will find the leaking pipe.

  20. Agreed, interesting how conditions take a back seat to rate with today’s consumer, it’s all about the quick fix…
    …It’s all good until the term progesses and needs change, suddenly the real price paid was the lack of education.
    Education is the true value add, and it’s mostly ignored by the key stakeholders in this game, the consumer, the broker and ‘Big 3’ for that matter….

  21. Doug I was shopping for my mortgage 2 weeks ago and was offered 2.99 for 5 year fixed from at least 3 major bank and 2.69 for 3 year fixed. So you basically answered my comment by demonstrating mortgage agents are limited, and that bigbank keep their best rate to walking client who aren’t afraid to ask.
    Now i Have been reading a lot of comments that it’s not only about rates, I would like to understand what other service a mortgage agent can offer because for me a 5yr fixed is a 5 yr fixed, and a variable rate is a variable rate so doesnt only come down to the lowest number.
    Lastly I do not intend to diminish the service of a Mortgage Agent or Broker, I’m just trying to understand, for example what happen when these small lenders closed down; what about accessing your mortgage info online and all other convenience a big bank can offer, so does all that worth that .05 point from a small lender (2.94%)

    1. There is far more than just rates and you’ll find out the hard way when you need to make a change to your mortgage part way through the term and get hit with penalties calculated using a BS post rate as though your big bank gave you a discount. Even though they we just being competitive to get you in the door. You also see at renewal time, when they give you higher rates because you can’t switch anywhere else due to a “collateral” charge registered on title for far more than you actual mortgage. These are the things your bank doesn’t tell you, but a good broker will.

  22. The bottom line is that in this day and age their is no excuse for not at least taking the time to inform yourself of the parameters and current competitive rates of one of the largest, potential costliest and usually vital financial products of ones life. A 0.05 difference in basis points can add up to a significant amount of money (not accounting for inflation) over the total life of a mortgage. Yes, shop your rate as any savvy investor would, but more importantly than rate is finding the product that is suitable to your needs and constraints at that current time in your life ie: pre-payment penalty, lumpsum policy, skip a payment option, etc. Then when u have a good understanding of your needs and the required product parameters, shop around (home bank and brokers alike) for the best rate. BEWARE!!!! Each have differing motives for selling you particular product at various rates. Remember that brokers get paid in various manners which can skews their motives Vs banks who pay there employee salaries (minding light bonuses due to sales revenue generated by selling other products besides mortgages) but who are limited to dealing with just their underwriters and their products alone. The bottom line is you as a consumer must make the effort educate yourself about the product and current market environment, and choose to go with whom you feel gives you the best bang for your buck.

  23. I couldn’t agree more. It is always best to do your own due diligence. Not all brokers are like this but many are. It is up to the buyer to educate themselves about what is going on.

  24. 2.69% on 3 year was an excellent rate. 2.99% fair. I could have offered you 2.94% and over last weekend I saw 2.88% being offered by an agent. Look. For some people the small % difference does not matter and that is fine. For others getting even .05 to .1% lower does matter especially if they are carrying a large balance. What is NB and it has been mentioned many times here is that it is the responsibility of the consumer to do the research and then decide what type of mortgage they want.
    When a lender shuts down or is taken over the mortgages are still serviced the way they were before.
    I would like to suggest what I see is the major difference between a bank and a mortgage agent. Anyone can help an excellent credit worthy client get a great mortgage and it is done quickly. I placed a lot of people in First Line before it shut down. We obtain mortgages from the big banks also.On the other hand some people have seen their credit rating slip usually through no fault of their own. Perhaps a husband or wife lost their job or a construction guy was injured on the job and money is stretched thin and maybe credit card payments are late or missed. EI helps but it is capped and temporary.There are many reasons. Banks don’t want to deal with these clients. First Line had a “B” lender side as to Bank of Nova Scotia. They withdrew from this type of lending. This is where we play a critical role. We look for the companies that deal with these types. Many times it is a difficult process but if we get them a mortgage they save their home and can start to rebuild their credit. Certainly they will not get a 2.69% or 2.99% rate offered to them. Perhaps they have to pay a broker’s fee also depending on how the lender compensates the agent. But the client keeps their home and most are quite happy.
    Most people say that it could never happen to them to be turned down by a bank. But it has happened to many over these past couple of years due to the economic turmoil.
    You seem to imply that your credit is good and you can qualify for the best rates. That is good.

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