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Brokers Showing Their Hands. The Repercussions.

Showing cards FBThe public is increasingly aware of what mortgage brokers make per deal. And now, courtesy of pending regulatory change, they’re about to become even more aware.

Should that concern you as a broker?

If you like making full commissions, you bet.

Everyone from the CBC and Globe and Mail to trade magazines and consumer forums have published how FICOM (B.C.’s broker regulator) wants to force brokers to reveal their compensation (more on that). In time, other provinces may follow.

What Happens Next

If/when these rules pass, it could take just a few years for a critical mass of borrowers to realize: a) how, and how much, brokers are paid; and b) how they can use that knowledge to negotiate lower mortgage rates.

As this information comes to light, savvy price-shopping consumers will have a field day (savvy being the key word; more on that below). It’s kind of like knowing your car dealer’s invoice cost. It provides a basis for negotiation.

For many brokers, that is unequivocally a problem, a big problem. Tamsin McMahon at the Globe writes, “traditional brokers…argue that revealing their commissions will push clients toward discount brokers offering the lowest fees and rates.” You better believe it will.

Countless borrowers will gravitate to the obvious savings and increasingly opt for brokers who cough up more of their commissions. Who wouldn’t want to save an extra $1,000 or $2,000 in interest?

Where Things Take a Wrong Turn

Choosing the right mortgage isn’t just about the obvious savings. Anyone can compare a three-digit number.

Minimizing one’s borrowing cost relies on finding the unobvious savings, for that has the biggest potential impact on borrowing cost.

Unobvious savings come from:

  • more flexibility (e.g., not having refinance restrictions when you need to refinance, blend and increase restrictions when you need to borrow more, insufficient porting timeframes when you need to port, etc.)
  • lower fees (e.g., avoiding or minimizing prepayment charges, legal fees, appraisal fees, discharge fees, reinvestment fees, title insurance fees, credit line fees, etc.)
  • better strategies (e.g., optimal term selection based on one’s family, employment and financial circumstances, refinancing tactics to lower overall interest expense, early renewal to lock in or average down on one’s interest rate, timing one’s application to get better rates, prudently utilizing debt to invest, structuring rental portfolios to maximize future financing options, etc.)

Unobvious savings come from detailed product comparisons and careful client analysis. Will deep discount brokers, who typically can’t afford to spend 3 to 4+ hours advising clients, offer this same degree of counsel? Likely not, at least not one-on-one.

And if you’re a well-qualified, experienced, financially savvy mortgagor, you may not even care. You might save just as much with that no-frills online rate you found yourself. But that’s not the majority. There’s a reason why the majority of investors prefer advice, despite 30 years of online discount stockbrokering. Likewise, most mortgage consumers want and need guidance. They don’t have the time, skill or inclination to learn the lingo and make detailed comparisons of mortgage features and restrictions.

FICOM’s plan puts online discounters in the catbird’s seat. “It’s really simple,” Ron Butler told the Globe. “I operate on one-third the income of the average mortgage broker, so I don’t mind it being showed to people.”

For the most part, this author (who also has an online mortgage business) doesn’t mind either. For one, brokers should have nothing to hide when it comes to compensation. And second, FICOM’s rule will boost volume for Internet mortgage models materially, for at least a few years.

Ultimately, however, compensation disclosure will lead to bigger buydowns and it will drive down commissions industry-wide—faster than the Internet alone would have done.

This worries more than a few broker network bosses. Any business that takes a percentage of agent commissions—as opposed to a flat fee—is destined to take a haircut.

What’s Wrong With FICOM’s Plan

There is nothing inherently wrong with more disclosure. Various professions disclose their pay in black and white. But with most other businesses, there is less chance of people drawing conclusions about the product/service based on the compensation of the salesperson.

For example, all traditional realtors in a given province make about the same commission percentage. Knowing a buyer’s agent makes 2.5%, for example, shouldn’t cause you to doubt that realtor’s recommendations. The market, not the realtor, sets prices and their commission percentage doesn’t increase if they sell a higher-priced home.

With mortgages, however, compensation varies and is directly linked to price (the rate), term, short-term lender promotions, etc. Knowing the originator’s compensation alone tells you nothing about that mortgage. At any given time the best mortgage can pay the highest commissions and the worst mortgage can pay the lowest commissions, or vice versa. Not surprisingly, research shows that choosing a mortgage based on originator compensation can lead to costly mistakes.

It’s a Start

FICOM’s plan is on the right track. There is no question that a minority of brokers sell worse products for greater personal gain, and we’ve argued for years that something should be done about it.

But implementing this rule, as is, would be detrimental to hundreds of thousands of Canadians. Its flaws first need to be addressed.

For example:

  • It proposes disclosure of all economic benefits to the dollar. How do brokers know what they’ll be paid when lender bonuses are often contingent on future volumes?
  • It mandates this disclosure, but arms consumers with no information to interpret the data.
    • How do average consumers know if a 110 bps finder’s fee plus 7.5 basis points efficiency bonus plus $175 marketing dollars is reasonable for a 5-year fixed?
    • How do consumers know if their broker could have sold a lower rate for a similar product, and still made a normal commission?
    • How would consumers know if a mortgage that generated a lower commission actually entailed the lowest cost of borrowing?

If FICOM could provide benchmarks for these comparisons, that would be useful. That would put this disclosure in context. If FICOM had clear suitability guidelines, that would reduce self-interested mortgage recommendations.

Without this information, FICOM is delivering but one thing to consumers: more ammunition to negotiate rates. FICOM’s actions will expedite commission reductions in the mortgage broker business. In turn, brokers will need to close more deals to earn the same living. That means less incentive to spend 3-4 hours counselling clients and poorer choices for consumers who rely on that advice. That shouldn’t be a regulator’s decision to make, not unless their solution is bulletproof.

Only a minority of knowledgeable consumers with negotiation skills will benefit from this policy change, to the detriment of less educated consumers who arguably need the most protection. The proposed rule, as is, is not the answer. It is like a shovel with no handle, an incomplete tool.

Sidebar: Today, February 20, is the last day to send FICOM comments on these rules. You can do so at