In the U.K., a Different Standard For Broker Transparency

For perspective on institutional practices, nothing beats seeing how those practices differ elsewhere. Recently, I looked at how mortgage brokers and the lenders they deal with operate in the United Kingdom.

I have had invaluable help from Richard Hobson, a broker in the United Kingdom for many years who is now a broker in the United States.

The basic economics of the industry are essentially the same on both sides of the Atlantic. Assuming that the lender is satisfied that the broker is properly licensed or certified, the arrangement between them is simple. In effect, the lender says to the broker: "Here are my prices and eligibility requirements; you bring me an eligible customer, and I'll make the loan."

Lenders find it advantageous to work through brokers because it gives them nationwide distribution without branches or loan officer employees. Even a single-office lender can offer loans wherever there are brokers with whom it can do business. Lending through brokers is flexible; the lender who wants to cut its volume simply prices loans a little higher so that they stop coming. It isn't necessary to fire anyone or close offices.

Mortgage brokerage is an attractive occupation for energetic self-starters who like to be their own bosses and reap the full rewards of their efforts. If the opportunities are provided by lenders, there is never a shortage of brokers.

Yet mortgage brokerage practices evolved differently in the United Kingdom than they did here. Perhaps the most important difference is that the pricing of broker services is much more transparent in the United Kingdom. This greater transparency is closely related to differences in the way that lenders price mortgages.

The prices quoted by lenders in the United Kingdom are the retail prices available to borrowers through brokers. These prices are viewed as public information, and some lenders advertise them in various media or on their Web sites. An eligible borrower knows that he can obtain that price from any broker dealing with that lender.

In the United States, in contrast, lenders deliver wholesale prices, and only to the brokers with which they deal. Brokers then add their markups before quoting retail prices to borrowers. Lenders never publicly disclose their wholesale prices. Brokers generally don't disclose them either, because that would be tantamount to disclosing their markups, which brokers view as nobody else's business.

In both places, brokers are most often paid by the lender rather than the borrower, because borrowers generally prefer it that way. However, there is a major difference in the way this works. In the United Kingdom, payments to brokers are set by lenders. Although there are some differences, most lenders pay a fee of 0.35 percent of the loan amount on standard products to borrowers with good credit. On loans for investment rather than occupancy, the fee is about 0.55 percent. On subprime loans, the fee is 0.75 percent to 1 percent. These lender-paid fees do not vary with the interest rate on the loan.

In the United States, in contrast, lender payments to the broker are determined by the interest rate the broker delivers to the lender on the individual loan. Some brokers standardize the charge, referred to as the "yield spread premium," but many don't, charging what the market will bear.

In both systems, the broker might or might not charge an additional fee directly to the borrower. Where there is such a fee, the broker in the United Kingdom is legally obliged to inform the borrower of it at their first meeting. In the United States, the borrower might not be informed of the broker's fee until he receives a good-faith estimate of disclosure, which is not due until after the borrower submits an application.

A major consequence of the difference in transparency is that many U.S. brokers engage in opportunistic pricing, adjusting their markups to what they believe they can induce the borrower to pay. There is no opportunity for this in the United Kingdom. The average markup in the United States is more than 2 percent, at least twice as large as in the United Kingdom.

Brokers under both systems perform the same functions. In the United Kingdom, however, the system places more regulatory burdens on brokers.

U.S. brokers may work as hard per dollar of income, however, because they spend so much time on transactions that never close and therefore don't generate income. Lack of transparency generates distrust. That distrust causes many borrowers to try to protect themselves by flitting from one broker to another, or by trying to play one broker against another.

Next Saturday: Regulatory differences.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site, http://www.mtgprofessor.com.

© 2008 Jack Guttentag

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