There is a new Form 10 pursuant to the British Columbia Mortgage Brokers Act, issued by the Financial Institutions Commission (FICOM) effective June 2011. This form replaces the existing Form 10 with a much more specific set of disclosures related to conflicts of interest by a broker in relationship to his borrower clients. While the new form, and the discussion paper by FICOM, doesn’t specifically address conflicts of interest related to broker-lender relationships, some of the fundamental principals raised in the discussion paper do.
Why should a consumer care about disclosure regulations, and what exactly is a Conflict of Interest?
Consumers depend on unbiased advice from professionals. One of industry’s dirty little secrets is that most financial advisers, including mortgage brokers, are paid by product or service providers[SJ1] . Most residential mortgage finder’s commissions or fees are paid by lenders, except in those relatively less common situations where a broker directly charges the borrower a fee or commission.
Most of the time, when consumers get a mortgage through a broker, they assume that the broker is making a recommendation based solely on the client’s best interests– in other words, finding consumers the best mortgage for them, regardless of any potential financial benefits to the broker.
While professional mortgage brokers do their utmost to put their own compensation out of their minds when arranging a mortgage, it is a truism that “he who pays the piper calls the tune.” The simple fact that the lenders pay the broker creates a potential Conflict of Interest of sufficient import that regulators (like FICOM in BC) require disclosure of it.
The heart of the conflict of interest is the simple fact that brokers are most often paid by the lender. If all lender’s commission structures were the same or similar, and there were no broker incentives to work with a particular lender, the potential conflict of interest would mostly remain just that – potential. Any conflict of interest would be purely theoretical, since a broker would have no greater motivation to place a mortgage with one lender over another.
However, there are significant differences in compensation types, arrangements and commission amounts between lenders. On a single mortgage loan, a broker may earn anywhere from .25% to 2% of the principal amount as a commission. Various volume and performance bonuses range from 0% to .3% or even .4%. These different types of compensation can also make a huge amount of difference in terms of how much the broker will earn over time from placing mortgages, and the payment by the lender may be in a different form than just cash. Some lenders use points, which can be used for a variety of industry training programs, trips or promotional items. They may even be used to pay down the rate on a particular mortgage in order to offer a more competitive on price for a broker.
This means that deals offered to a client may vary if a broker is willing to forgo some of his commission to reduce the cost of the mortgage. The broker may even use points from previous deals to do this.
Clearly, compensation to brokers from different lenders varies greatly. One thing is common: lenders compensate brokers in order attract their business, and lenders pay brokers a great deal more money to submit the majority of their business to themselves rather than to other lenders. Brokers are strongly incented to place the majority of their loan applications with a small number of lenders in order to maximize their income from volume bonuses and other performance related compensation. Furthermore, if a broker doesn’t submit enough business to a lender over a reasonable period, the lender may well choose to take the broker off his authorized broker list.
A broker may not be able to submit a mortgage to the lender with the best rate, terms or conditions because the broker may not do enough deals in a year with that lender to be on their preferred broker list.
Brokers have a lot more to think about when placing a mortgage loan than simply which lender and which loan to recommend to the borrower. The borrower’s best interest SHOULD always trump any other consideration, including contracts or other considerations with lenders or other parties. Whether client best interest does trump broker self-interest is a matter of professionalism and experience.
The more experienced a broker, the less likely is he or she going to be influenced by lender incentives, at least on a deal by deal basis. This is simply because experience teaches brokers that no particular deal will make or break them financially, and the small amount of financial incentive offered by differential commission structures is insufficient to motivate improper behaviour. However, with increasing pressure from lenders on brokers to place more and more of the business with their preferred lenders, there is unrelenting pressure on brokers to conform to the lenders’ objectives.
What the new Form 10, and underlying policy statement, does, is make the disclosure of potential conflicts of interest more detailed and more fulsome. There are many other potential and real conflicts of interest that FICOM is seeking brokers to disclose on the form, most notably when sub brokers, brokers or their employers have a direct or indirect interest in the lender making the loan. They also require disclosure of all parties receiving compensation for any mortgage, such as a referring agent, co-broker or other party. [SJ2]
I think that the intention of the changes in the FICOM Form 10 and the policy discussion that accompanied that form to the brokers in the industry is good, as far as it goes. It’s really a matter of fairness in the marketplace and the consumer knowing and understanding anything that might influence the advice he or she is getting from their professional. Full disclosure of fees, arrangements and other compensation doesn’t eliminate the potential for conflict of interest or ensure fair treatment of the consumer of mortgage loans. It does, however, help level the playing field and give consumers the ability to ask relevant and penetrating questions about any mortgage loan recommended.
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