1% of the loan amount is typically commissioned to mortgage loan officers. We will explain why this commission is unfair and share with you a better alternative as to why loan officers should not receive any commissions at all.
The loan officer has the most important job as they are the primary contact for borrowers throughout the process of a mortgage application. As a return for their service, these loan officers usually get paid 1% of the loan amount as their commission. So on a loan of $300,000; they receive $3,000 as their commission. Almost every lender passes this cost on to the client by charging them with a higher interest rate and origination fees.
In our opinion, it’s unjust to pay commission to the loan officers who may not be representing the client’s best interest in the first place. That is the reason why some lenders don’t pay any commissions to their loan officers; instead, they pass the benefit to the customers by providing them with the most competitive rates.
Is this transaction in your best interest?
It’s the customers’ right to question if the loan officers are acting in their best interest. A good point is to ask: What is the method of loan officers’ compensation?
The loan officers usually get compensated in 2 ways:
- Through commissions, taken as a percentage of the total loan amount.
- Through incentives, for meeting specific targets or selling particular financial products.
Both of the above methods can create a conflict of interest. For example, because commissions are based on a percentage of the loan amount, some loan officers have incentive to stick you with higher loan amount to make their commission larger. That was one of the reasons for the 2008 mortgage crisis. Lenders aggressively authorized mortgages that most of the borrowers couldn’t afford, while they made a considerable amount in commissions. The 2015 movie “The Big Short” is an excellent example of that particular case.
On the other hand, sales incentives or bonuses are a method of compensation. You’ve probably heard of the famous Wells Fargo case where they were ordered to pay over $185 million to settle allegations that the employees open millions of unauthorized accounts to meet banks’ sales quotas and receive incentives. Now they are facing inquiries by the U.S. Department of Justice. Although the case is not about the mortgage industry, it indeed defines the negative impact of these sales incentives.
So what happens? The company sets very aggressive targets to cross-sell some other products. Employees in individual bank branches who cross-sold a specific number of checking accounts get incentives/bonuses along with their regular pay. To get those incentives, over 5,300 bank employees without customer’s consent set up more than two million fake accounts. In the end, the employees got fired for duping customers, and Wells Fargo ends up in serious trouble.
Technology to Get the Job Done Efficiently
Technology has played its part to make financial services more efficient; however, mortgage banks haven’t used it that well in particular. Why do so many lenders still rely on lots of paperwork and old fax machines to process information?
Using old methods not only slows things down, but it’s annoying as well. Processing even a single loan involves handling a massive amount of information, making complex computations, and validating thousands of rules. Computers are way faster and accurate in comparison to human loan officers and of course, more efficient at processing information.
According to the 2013 Oxford economic study, there is a 98% chance that computers will replace traditional loan officers in the future.
Although we don’t entirely agree that the loan officer’s job should be automated. We think:
- Computers should only do the calculations
- Customers should have direct and transparent access to these calculations.
- Human loan officers should provide support and guidance to the customers, and they should not be compensated with any commission to avoid any conflict of interest.
The Increasing Cost of Financial Intermediaries
An excellent example of a bigger, systemic problem of financial intermediation is loan officer’s commissions, where financial institutions charge fees for providing the service of connecting customers with their products.
Those charges are increasing every year since the last 30 years or more, even though the advancement in technology has significantly improved the efficiency of the process of financial transactions. As per a 2012 paper, these intermediary costs are at an all-time high.
We can decrease the reliance on expensive intermediaries by creating advanced systems that match clients to the right loan products and also provide clients direct access to these systems.
Is Financial Intermediation Even a Good Choice?
Not related to the mortgage industry, the investment management industry has an excellent example of how removing financial intermediaries could be great for everybody — opposed to traditional fund managers, an “Index fund.” automatically tracks and invests in the market thus reducing the cost of managing the fund.
According to SPIVA, index funds not only cost significantly less, but they also out-perform their human-managed counterparts funds. The index fund management strategy has been so effective that currently, these funds have increased their size to 34% of the market share.
An index fund is a perfect example that customers can benefit from other financial services (mainly mortgages) without using financial intermediaries.
In conclusion, your home mortgage should be in the best interest of yourself, and you want to make sure that your lender does not compensate their officers with the commission. Otherwise there is a more than likely chance that the loan officer is not looking out for your best interest, but rather their own.