Canada’s central bank’s latest research paper has mortgage brokers in its crosshairs. The Bank of Canada (BoC) just released a staff paper on mortgage intermediaries (brokers). In the working paper titled the Role of Intermediaries in Selection Markets: Evidence From Mortgage Lending, they compare broker-client outcomes to branch borrowers. The researchers found that broker-clients are riskier, and are exploited for greater profit.
Unchecked Mortgage Brokers Can Produce A Systemic Risk For Canada
BoC researchers found that mortgage intermediaries (brokers) often provide worse results for clients. The paper reveals that broker-clients tend to be higher risk and lower income. They also tend to use more leverage, have longer amortizations, and pay more interest. Increased costs are partially attributed by the researchers to “steering” clients to more profitable products. Not exactly a love letter from the central bank.
The central bank isn’t just picking on brokers today, but looking to inform policy. They explain that if left unchecked, a toxic industry can lead to market distortions. Research showing how intermediaries drive excess capital to bonds and insurance are cited.
The top of their mind appears to be the ability for policy to respond to the current environment though. There’s mention of the role mortgage brokers played in the US housing bubble, and its collapse. After all, you need to identify if a problem exists before you can craft a response.
Riskier Borrowers Have Been Flocking To Canada’s Mortgage Brokers
The paper found that mortgage brokers service a higher risk clientele. “Specifically, they have lower income and lower FICOs [credit scores], but buy more expensive homes using longer amortization periods to smooth-out monthly loan payments,” explains the researchers.
Longer amortizations means a longer repayment term. Borrowers do this for lower monthly payments, in exchange for paying more interest. Not a little either—it can add tens of thousands to the cost of a typical home. Despite opting for tools to lower payments, they also found these borrowers tend to hit their total debt service (TDS) limit.
The TDS is the share of income dedicated to regular debt payments. It includes all regular debt repayment, such as your car, and credit card minimums. Borrowers with higher TDS ratios are more likely to default or be a forced seller. More income spent on debt repayment means less is needed to derail a borrower’s ability to pay.
Canadian Mortgage Brokers Extract More Profit From Borrowers
The BoC researchers argue that broker-clients use products that generate more lender profits. This typically occurs through a longer amortization or increased use of leverage. Steering is partially blamed for the trends observed.
Steering is a sales term for directing clients to an outcome preferred by the seller. It’s used to maximize profit by limiting options, or emphasizing profitable ones. They aren’t lying per se, but downplaying, or not presenting the best options. It’s a common tactic used in sales across every industry, and a good reason to be informed when shopping.
The researchers modeling estimates over a quarter of consumers choose costlier products. Half of this is attributed to steering, adding an average of 4.5 years to the amortization. They estimate eliminating steering would save consumers tens of thousand in interest payments.
The researchers also suggest that steering influences down payment size. Smaller down payments mean a higher loan to value (LTV) ratio, and a larger loan. Once again, that means more interest is paid. However, it’s not entirely due to steering. They also suggest that broker clients have a preference for higher risk products.
Canada’s Mortgage Broker Risks Are Amplified By Demographic Skew
Client preference and selection bias are two important factors to keep in mind. It’s hard to isolate broker-originated mortgages that a Big Six bank would reject. “The simple truth is brokers arrange mortgages in many cases for clients that the Big 6 banks turned down,” explained mortgage broker Ron Butler, founder of Butler Mortgages.
Butler emphasized the variance of borrowers that end up at mortgage brokers. Since borrowers that can’t be financed at traditional lenders are included, they provide a skew. This includes users of B lenders, often used by equity rich but credit poor households.
Previous BoC research found that mortgages from non-regulated financial intermediaries (NRFIs) aren’t much riskier than Big Six loans. These mortgages are done through a broker, and the data confirms the loans tend to be larger. However, NRFIs were also found to offer the lowest rates to attract those with the best credit scores.
At the same time, there’s no shortage of questionable mortgages at Big Six banks. Due to the sheer volume of the market, riskier loans tend to be diluted with higher quality loans. “In some cases the leverage is higher but we have also seen Big 6 Banks do wildly leveraged deals on HELOC + Rental purchases,” said Butler. Adding, “as to steering clients to higher commission products, sure that does happen.”
Commission steering is bound to happen in an incentive-based environment. Though it’s not always a case of greed, explained Butler.
“In some cases Brokers steer clients to very expensive Private Mortgage solutions only because it’s easier and pays the same as a B lender like Home Trust. I am serious, some brokers steer clients to the most expensive solution because it’s less work—not even better pay. The bastards are just lazy,” he said.
More transparency would help eliminate the impact of steering, suggests the BoC staffers. They cite Alberta and Ontario’s rules of compensation disclosure as encouraging. BC also gets a shoutout, requiring even indirect compensation to be disclosed.
However, regulation transparency only helps consumers if they know it exists. A borrower with no knowledge, depending on the broker, is playing mortgage roulette. They may get a fantastic broker, they might not. Although, it could also present a risk at a Big Six bank as well.
The best defense in this case is baseline knowledge. Borrowers don’t have to know everything about mortgages, but they should know what to expect. Brokers being required to do something doesn’t help if a borrower doesn’t know it’s required, or fails to understand what’s being presented to them.
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I knew brokers who could get you a 2 million dollar mortgage overnight for a fee of course. They had people on the inside who worked in the banks. Everyone got paid and you get the mortgage. The question is, can you afford the payments at the end of the month.
One wouldn’t expect the mortgage broker (Mr. Butler) quoted in the article to have read the section in Marx’s Capital volume one, where Marx describes in detail the ways in which profits are boosted by reducing the difficulty and time it takes to produce and sell a commodity.
However, Mr. Butler is no-doubt familiar with the common aphorism, that “Time is Money.”
So it is rather surprising that Mr. Butler thinks “Some brokers steer clients to the most expensive solution because it’s less work…. The bastards are just lazy” and “it’s not always a case of greed.”
Such a neat encapsulation of the reckless behaviour of mortgage brokers simply obscures a truth of this dangerous industry.
Manipulating customers into products that are more quickly produced and sold is almost always more profitable for the broker. The faster they can push a customer through their sausage machine, the more sausages they can produce in a given time period.
Time is money, Mr. Butler. We might also add that laziness is money too.
What could go wrong? It’s not like this practice touched off a worldwide crash in 2008.
Why is the taxpayer even guaranteeing mortgages against default in the first place.
Banks make money issuing these sub-prime mortgages, yet the taxpayers are made to pay when these mortgages default.
We need to get rid of central banking all together. Its turned into a means of privatizing profits and socializing losses.
The market should price real estate and the risk of mortgage defaults, not the govt which gets taken over by banks to guarantee their bets.
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