Competition in the mortgage origination market has benefited consumers, full stop.
Two years ago I wrote this column. It provided evidence that a strong broker channel keeps lenders competitive, thereby benefiting consumers. The same holds true today.
While broker share is approximately 30% of the total market, it operates as a check on the system, forcing all channels (including branch and mortgage sales force reps) to sharpen their pencils.
According to Bank of Canada research cited in that column, customers who used a broker saved an average of 19 bps on their mortgage financing. On renewals, where incumbent lenders retain anywhere from 70 to 90% of customers, broker clients saved significantly more.
But while consumers are reaping the benefits of a strong broker channel, there is growing competition amongst ourselves, and it’s driven largely by rate. A rate war in the brokerage channel may ultimately serve to undermine consumers, not help them.
I want to make two things clear:
I do not equate “online” mortgage brokers to low rates, although that is a popular connection to make. Brokers can (and ought to) have strong presence online and in social media. But they do not have to lead with rate.
I am not disparaging rate discounters. I can fully appreciate the importance of multiple models and offerings — especially within our small mortgage community where experts have told us time and again to differentiate.
I understand that some discounting will occur, however how much should brokers discount?
For context, to provide an additional 10 bps rate discount, a broker will give up approximately half of the gross finder’s fee earned on a typical 5-year fixed or variable mortgage. For many brokers who earn volume bonus as part of their compensation, that discount shaves approximately 35–40% off their total gross income.
The other side of the question is equally important. For a broker to give up 40% of their earnings, how much does the average consumer actually save over a 5-year term?
Consider a $300,000 5-year fixed mortgage with a 25-year amortization. Comparing 2.89% to 2.79%, a borrower would save about $982 (factoring in the slightly lower payments and increased reduction in principal) depending on which duration is used. Keep in mind, the average 5-year mortgage only stays on a lender’s books for roughly 3.4 years. Using a 4:1 buydown ratio and an average gross total income of 105 bps, the cost to the broker was $1,200. The ratio of broker buydown to customer savings is 0.81 (based on a 41-month duration). The customer incentive is not of relative value.
Considering today’s historically low rates, the amount of discounting in the current market is less significant to a mortgagor than if rates were in the 4.79% range.
Some would suggest that in saying this, I am not a consumer advocate. I say the exact opposite. If we fail to maintain a strong and vibrant brokerage channel in Canada, Canadian borrowers will suffer as a result.
For a typical AAA salaried borrower who gets a 2.79% 5-year fixed mortgage from a broker, they are saving approximately 20 bps off the lowest advertised bank rate. That is still meaningful savings.
Furthermore, what other industry would provide consumers with a rebate that was disproportionately less than the income the sales rep was sacrificing to provide it? If a Realtor rebated 40% of a 2.5% commission, that would equate to a cash incentive to the customer in the same amount (e.g., $4,200 using a $440,000 selling price).
The ratio of broker buydown to client savings is excessive in light of other industries. The risk to the consumer is that buydown rate wars lead to reduced competition, which leads to less overall discounting in the mortgage market.
A few last points to consider:
For companies that are marketing themselves as providing the best rates, are they also brokering non-prime and private mortgages? If so, do they discount those rates and fees as well? Shouldn’t all their consumers be entitled to the lowest cost of borrowing?
Should insurance brokers give up part of their earnings to buy down premiums? The Financial Institutions Act says no and section 79 (1) outlines to what extent rebates of premiums are prohibited. It establishes 25% as the maximum rebate payable.
Lastly, many companies entered various markets with an eye to be the low-cost provider. One in particular stands out as a tremendous success story: Southwest Airlines (LUV). For many years it gained market share by competing on price. To do so though it had to simplify its operations, serve new markets and cut services to consumers. Usually there is only room for one low-cost provider in an industry. As multiple companies start competing on price they do have the effect of creating a price war, but in the end the model becomes unsustainable and businesses have a difficult time operating on reduced margins — often pushing some companies out of the market. In an effort to enhance margins, even Southwest has introduced fees for checked bags, preferred seating, etc., to remain financially viable.
The current historical low rates being offered are maintaining a vibrant housing market in Canada. Even if rates start to increase, it is choice that fuels competition and that underscores the essence of the broker value proposition. For choice to be available — a variety of companies need to be active — and to stay in business, the financials need to be sustainable.
Given the relative value to the customer of rate buydowns, engaging in this practice may jeopardize and marginalize the value of a brokerage proposition predicated on choice and competition.