August 5, 2007

Putting brokers out of commission
Entrepreneurs of new online home loan sites say their systems are better aligned with consumer interests.
By MATHEW PADILLA
The Orange County Register

Exorbitant commissions have given some mortgage brokers a bad name, experts and consumer advocates say.

But a couple of entrepreneurs with ties to Orange County say they have a better way to sell mortgages to consumers – one that gets consumers the best deal and allows the brokers to still make a living.

Joseph Fox and Jeff Lazerson recently launched separate Web sites that they say take broker commissions out of the equation, leading to better deals for consumers. They focus more on volume, using the Internet to provide cheaper loans to consumers, they say.

Lazerson said currently many brokers are motivated to get the highest combination of points and fees.

"They take the borrower's temperature to see what they can get away with," he said. "It's an advisory relationship; they say they are a trusted adviser, while they are really a wolf in lamb's clothing."

Right now the Lazerson and Fox sites have small audiences, but there may be a great potential for growth in California. Brokers handle about 60 percent of loans made in the Golden State, according to the California Association of Mortgage Brokers.

That's a lot of loans for what generally are a series of small independent shops. For example, in 2005 there were $724 billion in home loans made in the state, government data show. If brokers did 60 percent of those loans and charged on average 1 percent, that would mean they made $4.34 billion in fees that year.

INCENTIVE-SYSTEM NOT BEST?

It's clear brokers have a big effect on the finances of millions of Californians, experts say. A broker helps consumers figure out what type of home loan best suits their goals and income. They then survey lenders to find which offers the lowest interest rate on that loan type.

But Paul Leonard, a director in the Oakland office of the Center for Responsible Lending, a consumer advocacy group, says brokers have a financial incentive to steer consumers into more costly loans. Lenders pay them more to do it, he said .

Of course, lenders are also to blame, he said.

"All you have to do is look at rate sheets for subprime lenders," Leonard said. "Brokers are incentivized to bring in loans at higher interest rates."

Lenders pay brokers a yield spread premium for getting borrowers to pay an interest rate above the wholesale, or par rate. It's a common and legal practice that has withstood court challenges.

Michael LaCour-Little, a finance professor at Cal State Fullerton, studied 834 loans made in Florida in 2000, before the height of the housing boom. He found that consumers who used a mortgage broker paid on average an interest rate 21 basis points higher than those dealing directly with a lender.

For example, if a lender offered 6.5 percent interest to a retail consumer; the broker offered 6.71 percent on the same 30-year fixed loan. On a $600,000 loan, the difference would amount to more than $600 a year.

And he found that consumers using a broker paid more in interest on similar fixed-rate loans about 75 percent of the time.

LaCour-Little said he's currently analyzing a national database of loans and is finding similar results.

Consumers suffer because brokers earn more if they pay more, he said. Brokers earn commission in the same way that car salesmen or real estate agents do, he said.

And mortgage brokers are not a fiduciary of either consumer clients or lenders, he said. Their role is different from that of real estate agents who represent a home buyer.

"Imagine someone doing your taxes, and the more you pay the IRS, the more money he makes. It sort of breaks the bond of trust," LaCour-Little said.

ARE LOANS ON THE WEB A BETTER DEAL?

Enter entrepreneurs who say they have solutions to the mortgage controversy. They say the Web brought clarity and lower prices to airline fares. Why can't it do the same for home loans?

Fox, chief executive of Iggys House, Inc.in Chicago, is one of the men pushing a market solution to today's lending chaos. He has experience using the Internet to provide consumers cheap, fast service.

His previous venture was online stock brokerage Web Street Securities, which he sold to E*Tradein 2001 for $45 million in stock.

Now he's doing the online real estate thing. He recently launched www.buysidemortgage.com – an online mortgage brokerage, for now just in California, where brokers are salaried employees.

His brokers don't earn a commission for closing a loan, a radical concept for the lending business. Instead, Fox awards bonuses solely on customer service, which is judged by their supervisors and from customer surveys. Hence, employee incentives are aligned with the consumer's financial goals and needs, Fox said.

He started the business because he felt brokerages needed change. And he saw a "huge opportunity to make money," Fox said.

Fox runs a couple of related real estate Web sites, including www.iggyshouse.com, which allows sellers to list their home on the Multiple Listing Service for free. The company also owns buysiderealty.com, which rebates 75 percent of the seller's commission in a home sale to the buyer. It keeps the other 25 percent.

As for buysidemortgage, Fox makes money from yield spread premiums. Like more traditional brokerages he gets paid by lenders for charging consumers an interest rate that's higher than the wholesale rate.

"Generally that's how we make money," Fox said of the yield spread premiums. "But we will take a smaller amount to get a better rate for the customer. We work in a margin that we can still make money."

Fox argues that since he's not paying employees big commissions to close loans, he can afford to accept a low premium. He said most of his business so far comes from buysiderealty.com.

The president of San Diego-based BuySide Mortgage, David Cohen, lives in Lake Forest and plans within the next few months to open an Orange County office where he will spend most of his time.

ANOTHER MODEL

Lazerson, a longtime broker in Laguna Niguel, in December launched www.mortgagegrader.com, a site he said anonymously submits borrower debt and income information to participating lenders and gets the lowest available interest rate from them.

He said the system matches each borrower's credit profile with an appropriate loan, whether prime or subprime – loans to people with shaky credit. The process avoids having a broker steer someone into a higher cost loan to make money, and thus should avoid setting buyers up for a loan they can't really afford and eventually having them lose their home due to broker greed, he said.

Lazerson says his brokers work on a flat commission structure, with slight variations for loans size, and that that's all disclosed to the consumer. If the yield spread premium turns out to be more than planned, the extra cash is rebated to the borrower, he said. He said other brokers have the wrong incentives and pay structure.

Leonard said the Center for Responsible Lending reviewed Mortgage Grader and that such online sites are a step in the right direction for consumers. But his group doesn't endorse private ventures.

"I think that there is the possibility that the use of technology can present a helpful alternative, but I think we would maintain that you still need some fundamental rules out there and standards in the marketplace," Leonard said.

He said brokers are too divorced from risks of loan defaults. They need to be held more legally accountable for bad loans, he said.

BROKERS SAY COMMISSIONS NOT THE PROBLEM

Harry H. Dinham, who recently served as president of the National Association of Mortgage Brokers and is a broker in Plano, Texas, said commissions aren't the problem.

Consumers need to shop around, get price quotes from at least three lenders or brokers, and then sit down with a broker to hammer out a deal, he said. Dinham explains his fees upfront and recommends all brokers do the same.

Brokers and lenders normally charge a fee of 1 percent of the loan amount to make a loan, though other fees may be included, he said. The origination fee can be a straight cash payment or the consumer can pay a higher interest rate, and the one point fee is paid to the broker by the lender, he said.

Dinham said brokers are legally required to report yield spread premiums, but lenders don't have to disclose what they make selling a loan.

And he said online sites often advertise low fixed fees, but then charge a higher interest rate.

"They are putting all the fees into the loan itself," he said of online sites.

Besides, he said, "If you're financing up to $1 million, you don't want to do that over the Internet."

Dinham said the industry does need a national licensing or registry program for all loan originators, including brokers and loan officers at banks. He said today's bad apples can just pick up and move to another state, or in some cases work for a different lender in the same state.

He said lenders generally aren't required to do background checks on employees and their loan officers don't have to be licensed.

"One of the biggest problems we have in our industry is fraud," Dinham said. The reality that "you can commit fraud at one place and then go to another place the next day is kind of amazing."