Loan Originator compensation is one of the world’s last big mysteries. Fortunately for you, I am here to provide the answers. When I say Loan Originator, I am referring to mortgage brokers and loan officers at banks. The term is being used generically.
For the most part, all Loan Originators work on 100% commission basis and wouldn’t have it any other way. Salaries are a for wimps. They are only paid when your loan actually closes. The LOs compensation is derived from the fees paid on a loan and can be structured in any number of ways. Regardless if you see it or not, LOs are going to get paid as no LO is going to do a deal for free on purpose.
LO compensation can range from as little as .5% to 4% on a deal with typical fees ranging from 1 to 2% of the final loan amount. So if a LO is making 1.5% on $400,000 transaction, the compensation amounts to $6,000. While this is a lot of money, keep in mind that it is also usually split with the LO’s employer. For simplicity, let’s assume 50/50. So the LO gets $3,000 for the transaction and their employer keeps $3,000. While that seems like a lot of money for one transaction, most LOs don’t do a substantial amount of business so that might be their only closing that month. In addition, LOs spend an inordinate amount of time working on deals that die on the vine so they are not compensated adequately. Obviously, if the LO is a top producer closing dozens of transactions each month, you can see that the sky is the limit in regards to income which is why the field is so popular.
LO Compensation is paid in one of three ways: 1) Buyer 2) Lender 3) Combination of Buyer & Lender
Buyer Pays: When the buyer is paying the LO, it is usually in the form of points or an origination fee. The loan officer tacks on his 1.5% or the agreed upon amount as part of the closing costs. Typically, this will allow the borrower to get a lower interest rate. Even though you may get a lower rate, this may not be the best approach unless you plan on staying in your home for a long time. It may takes three or four years to breakeven from paying points.
Lender Pays: When the lender pays, it is known as Yield Spread Premium (YSP) in the case of brokers or Service Release Premium for mortgage bankers. Instead of offering you 6% with 1.5% in points, the LO may offer 6.5% with no points. The 1.5% that the LO desires for compensation is instead paid by the lender for giving you the 6.5% rate instead of 6% rate. By doing it this way, you don’t have to come up with thousands of dollars in additional closing costs. The higher the rate, the larger the YSP/SRP paid to the LO.
It is important to note that if a loan has no points/origination fee then there is ALWAYS a YSP/SRP being paid to the LO. By law, mortgage brokers must disclose the YSP they plan to earn on the Good Faith Estimate and any YSP will always be shown on the final settlement statement. Mortgage banks are not required to disclose their SRP.
Specifically, YSP has come under fire because many consumer groups believe that since the final rate increases as YSP increases that the LO has an incentive to upsell rates as much as possible. While this is true to some degree as it is with any business that wants to make a profit, it is impossible for a LO to gouge a consumer who is proactively shopping for a mortgage. If you have a standard mortgage and an LO is trying to make 3% on it when most LOs would probably do it for 1-1.5%, a few phone calls will quickly result in the gouging LO to be undercut by the competition as their final rate will be significantly higher than everyone else.
With few exceptions, most lenders offer rates within a very narrow range. As such, most good LOs know when a borrower is being bait and switched because the YSP will not be available to realistically offer the rate to the borrower profitably.
Buyer & Lender Pays: Sometimes the LO may structure the deal so some portion of the compensation comes from the borrower and some from the lender. For instance, say the LO needs to make a total of 2% on the deal to feel adequately compensated. The LO may charge 1% origination and receive 1% YSP/SRP from the lender.
Alternative Approach – Upfront Mortgage Brokers/Lenders
In order to prevent any inpropriety on the part of the LO, many have been operating in an upfront manner by agreeing to a set fee upfront with the borrower. For example, a borrower agrees to hire an LO as an agent and pay the LO 1.5% (or whatever is negotiated) of the final loan amount for securing their financing. In turn, the LO agrees to share their wholesale interest rates from their approved lenders with the borrower. With this approach, the goal is transparency from both parties. The LO can focus on the consumers needs knowing ahead of time that the borrower is not rate shopping them and the consumer can trust that the LO is working on their behalf in a transparent manner.
Many LOs have been doing this for years, myself included, but the practice was branded by Wharton Business School Professor, Jack Guttentag aka The Mortgage Professor. He calls this approach Upfront Mortgage Brokers/Bankers or UMB.
While the transparency of UMB has some advantages, it really only works when you are dealing with mature consumers who understand money, service, and value. Most consumers prefer to just call around and see who gives them the lowest rate quote ignoring all the risk inherent with that approach.
It is important to note that dealing with a UMB DOES NOT assure you get the lowest rates. It only guarantees the loan officer’s compensation and that they will be working on your behalf. While there is a linkage between LO compensation and rates, it is not linear and varies greatly depending on what lenders a loan officer has access to in regards to rates and programs. In other words, it is entirely possible for an UMB who agrees to 1% compensation to offer higher rates than a broker who is making 2% in compensation. However, it should not be the rate or the LO’s compensation that is driving the consumer to the UMB, but being able to work with someone who is transparent, trustworthy, and who will not surprise you at the closing table.
The bottom line for consumers is that you should never be afraid to ask how the person representing you in your largest financial transaction is compensated.