Surviving the Sprint to the Bottom

Falling interest rate FBLots of brokers out there criticize rate buydowns. They argue that buydowns cause a “race to the bottom” in mortgage pricing.

If that’s how you feel as a mortgage broker, take solace. The race isn’t far from the finish line.

Online mortgage rates have already plunged to levels where some brokers now earn just 35 basis points in compensation (or less), even on five-year fixed terms. That’s one-third of what most brokers make.

At these revenue levels, only a minority of exceedingly efficient large-scale brokers will succeed long term in the deep discount market. As more independent mega-brokers sign on directly with funders (à la True North Mortgage) and/or negotiate $50-$100 million volume deals with lenders, that’ll become all the more true.

Adding to this trend is the virtual certainty that more lenders will launch DTC (direct-to-consumer) call-centre models and sidestep originator commissions. And, of course, our major banks won’t be left behind. CIBC has already flashed a glimpse of the future by negotiating rates on borrowers’ smartphones and bypassing traditional mortgage specialists.

Thus far, the rest of the broker industry (those without deep discount models) seems largely unfazed by these developments. Canada’s top mortgage agents— the 20% that do 80% of the volume—have profitable existing books of business and established referral sources. In their view, they can sufficiently sell their value to clients. Moreover, their volume has yet to take a serious hit.

Then we have the lean-minded so-called “order takers.” These are online shops willing to work for 35 bps. These are the guys who have started to move the market for all brokers—regardless of experience, referral sources, salesmanship, advertising, value propositions or what have you.

I increasingly hear from $200- and $300-million producers who are losing deals over 5-basis-point rate differences. This is something that rarely happened to them in the past, but it’s occurring with more regularity today.

As time goes on, brokers will hurry to find solutions to this problem when, in fact, one key solution is the same as it always was: dollarization.

In industry terms, dollarization is the practice of articulating the value (in dollars) that customers receive from your advice and assistance. It’s an effective strategy given the commoditization dilemma, but it’s not easy to execute. 

The question you’re trying to answer as a broker is: What is it worth to someone, monetarily, if I find them the optimal mortgage?

“Optimal” refers to the mortgage with the lowest cost of ownership and the best customer experience. Getting a theoretically optimized mortgage is worth something to people because it saves them time and money (interest cost, penalties, refinance rate surcharges, conversion rate surcharges, reinvestment fees, discharge fees, etc.).

But here’s the rub. Identifying the lowest cost of borrowing for a particular client takes serious work and analysis. It entails something like this:

  • asking the right interview questions upfront
  • understanding a client’s five-year plan
  • calculating the probability of certain life events occurring in that timeframe
  • objectively comparing features and restrictions for several mortgages
  • mathematically ranking which mortgage (or series of mortgage terms) are the best value over five years
  • explaining that to consumers in a way they understand (and believe), with hard numbers to back it up, and
  • ensuring the customer doesn’t take that knowledge and go elsewhere.

Note: We focus on five-year time horizons because: a) mortgage terms over five years are not cost effective at today’s rates, and b) predicting the future beyond five years approaches futility.

In an era where online rates are often 20+ basis points below median broker rates, failure to optimize people’s financing and dollarize that service may become a death warrant. It boosts the odds that customers evaluate you on price, and price alone. And that’s a bad outcome for the more than 95% of brokers who don’t/won’t have the buying power and side deals to compete on rate.

When the “race to the bottom” is officially over, those who prosper against the Walmarts of the mortgage industry will be the professionals who can persuasively explain why their higher rates are not just padded profits. Many quality full-service brokers believe that their service to prime borrowers is worth an extra 20+ bps. In most cases, it’s not. But it’s not worth just 1-2 bps either, and effective dollarization can get that across to folks.

  1. Great post from Rob. Not to take anything away from Fox News but this article is “Fair and Balanced”.

    Dan Eisner of True North had a great comment on this subject, he said: the finder’s fees on mortgages represent a gross margin, the mortgage broker chooses how he or she works within the framework of the gross margin.

    So discount or full price everyone gets to pick their spot and work their business model to have a successful outcome.

  2. As a BC mortgage broker I’m hesitant to put in all this effort when a client can just take my valuable advice to the next broker down the street. FICOM has done a huge disservice to consumers by not allowing brokers to charge cancellation fees. I can only hope that FICOM heeds MBABC’s recommendations and relents on this issue. Otherwise, mark my words, BC brokers will provide less in-depth advice in this crazy rate-obsessed market.

    1. @Vanbroker

      Thanks for the comment.

      Fee for service has served consumers well in other financial verticals like investments. There’s no question that FICOM’s, FSCO’s and other regulator’s prohibition on advanced fees limits consumer options. Borrowers in these provinces cannot pay licensed agents like consultants, for example, in exchange for unbiased advice with no obligations. Nor can people get the lowest possible rates from providers who rely on cancellation fees to manage efficiency. The MBRCC needs to put fee review on its regulatory agenda and get provinces talking about this issue.

  3. > Identifying the lowest cost of borrowing for a particular client takes serious work and analysis

    Unfortunately I don’t think this analysis can’t be done by an app and a series of questions. This is the direction that many industries are going to take and younger consumers prefer it. Why go down to an office and spend a bunch of time talking to a salesman when you can fill out your needs and have a recommender system give the results? None of the considerations you mentioned are difficult to automate.

    1. Roboadvisors have proven that even something as complex as investment advice can be automated. The quality of that advice is an entirely different discussion.

      At a minimum, there will always be folks who want personal one-on-one interaction. Borrowers have questions and, believe it or not, some of them don’t want a digital response.

      As far as the difficulty in automating mortgage advice, as someone who’s actively pursuing it, I can tell you that it’s a heavily variable-dependent exercise that is anything but easy.

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