The Pricing of Mortgages by Brokers: An Agency Problem?
LaCour-Little, Michael, The Journal of Real Estate Research
Mortgage brokers have grown in importance in the home mortgage origination process in recent years, suggesting they provide a valuable service matching borrowers and lenders, although their involvement has also been linked to the recent surge in mortgage defaults and foreclosures. As in other markets dominated by brokers, agents' incentives are often poorly aligned with those with whom they do business, in this case both the lenders who bear the risks once the loan is originated and the consumer who assumes liability for the debt and contract terms. This paper describes the institutional arrangements under which mortgage brokers operate and empirically test whether loans originated by mortgage brokers are lower in cost than those that would be available directly from retail lenders. The results suggest that loans originated by brokers cost borrowers about 20 basis points more, on average, than retail loans and that this premium is higher for lower income and lower credit score borrowers.
According to a previous posting on the National Association of Mortgage Brokers (NAMB) website,1 mortgage brokers:
"are real estate financing professionals acting as the intermediary between consumers and lenders during mortgage transactions. A mortgage broker works with consumers to help them through the complex mortgage origination process. A typical broker has a working relationship with numerous banks and other lenders and provides the consumer with access to hundreds of options when it comes to financing a home. This allows mortgage brokers to provide consumers the most efficient and cost-effective method of obtaining a mortgage that fits the consumer's financial goals and circumstances. Mortgage brokers have helped many consumers, including low-to-moderate income borrowers with less than perfect credit histories, enjoy the benefits of homeownership."
The importance of brokers in the mortgage industry has grown significantly in recent years, especially since the availability of automated underwriting circa 1995. Again, according to NAMB, 53,000 mortgage brokerage firms employ approximately 419,000 loan officers, who produced approximately 65% of the residential mortgage loans originated during calendar year 2004. This is an increase from 52% of all loans in calendar year 1997 (LaCour-Little and Chun, 1999). Percentages for 2005-2006 may be still higher, though the recent mortgage market turmoil caused the percentage to drop to 57% for the full year 2007 and to 49% during the first quarter of 2008 (Inside Mortgage Finance, 2008). Moreover, real estate brokers, who often have mortgage broker affiliates or referral relationships, account for about 86% of all home sales in the United States during 2003 (National Association of Realtors, 2004). Comparing these percentages to the labor market, Posey and Yavas (2004) report that 35% of hiring occurs through employment agencies. Clearly, real estate and mortgage lending are areas in which brokers play a dominant role.
Using the Home Mortgage Disclosure Act (HMDA) data, it is possible to make some estimates of the revenue derived from the mortgage brokerage business. During calendar year 2006 (the peak of the housing market), approximately 14,000,000 residential mortgage loans were originated (Federal Reserve, 2007).2 This number includes both conventional and government-insured loans, for either purchase or refinancing, first and junior liens, and loans secured by manufactured housing, as well as HMDA-reportable multi-family loans.3 Moreover, since HMDA does not cover all loans or all originators, this is a conservative estimate of the size of the mortgage market. Assuming that brokers were involved with 60% of all originations, an average loan amount of $170,000 and that mortgage brokers earn on average 2% on a transaction, these figures imply total industry revenue of almost $29 billion in 2006.4 Such large figures have attracted attention in the business press (see, for example, Wall Street Journal, 2007). …