If you are a smart consumer you are aware that the ability to negotiate a fair price for closing costs is now a reality. The flat fee mortgage allows the consumer to pay a flat rate commission to a loan officer or mortgage broker rather than paying on a % (percentage) basis.

There are 3 main areas of costs for borrowers to consider when pricing a mortgage (refinance or buying a home):
1. Origination Fees - fees paid to cover commissions for the broker, overhead of the broker, salaries of office staff
2. 3rd party fees - underwriting, document preparation, appraisals, closing attorneys, courier, miscellaneous fees.
3. Overage - this is an extra commission paid to loan officer or broker. The "over" is derived from the amount the borrower agrees to pay over the best rate available at the time the loan is locked.

Origination Fees - Is 1% Fair?

In the 1980s the average new home price in the US was $76,000. A 1% commission fee to a mortgage broker for a home in this price range would generate a commission of $760. In 2005 the average new home price in the US has climbed to $274,500. At a typical charge of 1% origination fee (i.e. sales commission) the mortgage broker would be paid $2,754.00 in origination commissions plus a potential override known as a yield spread premium (YSP) which occurs when a borrower agrees to pay above par price for the interest rate of their mortgage loan.

To get the most from this article here are a few terms to need to be understood:

Above Par Pricing

Above par pricing is a tool that was created to be used when borrowers want to minimize out of pocket expenses at closing. By agreeing to a higher than market interest rate, the borrower receives a cash rebate at closing. The cash rebate is then used to pay for closing costs and is helpful for seek to minimize the cash out of pocket required to purchase or refinance. Spurred by increasing home prices and increasing down payment requirements the cash back at closing can be a useful tool for borrowers that are having a tough time putting together the cash to pay a down payment and the necessary closing costs.

Yield Spread Premium

The Yield Spread Premium is a somewhat fancy term for what is essentially an extra commission or an "overage" paid to mortgage brokers by wholesale lenders. The spread is the difference between the rate (price) the consumer agreed to pay the broker for the money and the rate (price) the wholesale lender is charging for broker for that same money.
The premium is the actual cash value of the rate spread. The higher the spread, the higher the premium. The higher the loan amount, the higher the premium. Since the broker is essentially acting as a middleman they are in a position to have more and better information than the borrower about the true price of money.
The system is set up so that the broker can be paid a bonus for his ability to sell the borrower at a higher rate than wholesale lender is charging. The higher the rate, then more premium is paid back to the broker by the wholesale lender. If the broker refunds all the overage to the borrower then it is considered a cash rebate to the borrower. If the broker keeps some or all of the premium, it is classified as an "overage fee" and is pocketed by the broker as a bonus for selling the borrower at a higher than necessary interest rate. This practice has created a strong motivation for borrowers to go "mortgage shopping" and to talk to multiple brokers before locking an interest rate.

About Interest Rates

Ultimately the interest rate is a reflection of 3 things. The borrower's risk of default, the value of the underlying asset and the current demand/supply of money on Wall Street.
Mortgages aren't priced like retail goods or automobiles. Mortgage rates are the result of the demand supply movements of the bond market. Because of this underlying very volatile price factor, the cost of money fluctuates day-to-day, hour-by-hour, even minute-by-minute.
A mortgage broker or loan officer can have a difficult challenge to quote accurate rates, especially for home purchasers that are seeking prequalification. Until the borrower has made application there are too many unknowns. Until credit scores have been checked, qualifying ratios calculated and down payment and income sources verified, it is nearly impossible for the mortgage broker to truly know an accurate rate to quote a borrower. Companies will advertise a low teaser rates on radio, TV or the internet in attempt to get potential borrowers on the phone. Ultimately each borrower is unique, the property is unique and interest rates are customized for each borrower and co-borrower due to varying characteristics and circumstances. Once the borrower's risk is determined only then do the minute-by-minute price fluctuations of the market become important
Low credit scores( due to slow or no repayment of prior debts), bankruptcy, work stability, current income and current indebtedness (credit card minimums, student loans, car payments) all factor into the borrower's interest rate. Higher down payments, property location and resale potential lower the risk of default and increase the likelihood that the holder of the lien can offer the home for quick sale in case of foreclosure.
All of these factors and more ultimately determine the rate the broker can acquire funds from a lender on behalf of a particular borrower. Once this wholesale rate is determined then the broker may attempt to pad the rate, either to make more money or provide a cushion if rates go up before a lock can be executed.

Mortgage Brokers and the Agency Problem

Unfortunately the borrower isn't usually told the wholesale rate (i.e. the cost of money) that the broker locked from the lender therefore the broker can create a gap or spread in the rate that is charged to his borrower. The bigger the spread or gap between the wholesale and retail cost of the money, the bigger the commission paid to the broker or loan officer. This isn't an evil exercise however is puts the broker in a situation where what is best for his customer is not necessarily best for his paycheck. This is called an agency problem and exists when an agent and a client have potentially opposing needs or motivations.

What about Free Closing Costs or No Closing Costs mortgages?

The "no closing costs" or "free closing costs" marketing pitch is simply a loan that has been priced above par (see Above Par Pricing). This is a popular pitch on radio and TV as the hucksters want to "do your loan for free".

As your mother taught you:
Nothing good in life comes for free and this is no exception.

Here is how "free mortgage" game is played:
In exchange for "free closing costs" you simply agreeing to pay a higher interest rate than you would or possibly should. The broker sells your loan to the lender at a premium and by having you accept a higher than market rate your broker is going to get a large Yield Spread Premium as a rebate (i.e. kickback) from the lender. The rebate is then used to pay your closing costs. As your mortgage broker pockets the YSP and you get a "free" closing and a higher interest rate. If you pay the higher interest for a year or two and then refinance or sell the home then this might be a legitimate alternative. However keep in mind that you are taking a gamble at some level. If interest rates rise or if you lose your income or your credit score drops then you may not be able to refinance and you may have to hold that higher interest note much longer than you planned. Additionally, the higher rate will likely require a higher payment creating a more risk for default or foreclosure due to inability to pay the principal and interest. Sometimes the broker will add the flex pay option which is essentially a negative amortization loan that can create a scenario where a borrower has negative equity in their home (this is not a common scenario however it is a possibility that needs to be discussed and recognized by the borrower).

Enter the Flat Fee Mortgage

The flat fee mortgage is an attempt to remove agency problems, reduce the tension between broker and borrower and eliminate the risk of a borrower overpaying for their interest rate and closing costs.

The flat fee mortgage allows the broker to be paid a flat fee for their time and expertise.

Instead of playing rate games and concealing information, the flat fee mortgage is handled by allowing the consumer to lock at the wholesale cost of money or at an agreed upon spread. This removes the need for the broker to create hidden yield spreads as the broker's fee is "flat" or locked before the process begins. The broker does his due diligence, helping the consumer become more "lendable" and spending his time finding the best wholesale rates available. The consumer doesn't have to call 10 brokers and play the "rate game" and a level of trust between broker and borrower can truly be established as both parties' interests are aligned.

How to Clean Up the Mortgage Broker Mess:

There are a 2 simple yet powerful changes that need to take place for Mortgage Brokers to stay relevant as Congress seeks to take action against the mortgage broker industry.

Flat Fee Mortgage Compensation Model
Loan Contract

1. Flat Fee Mortgage - removing the agency problem in the mortgage business:
The flat fee mortgage is a simple yet elegant way of doing business. It removes the agency problem that is at the core of the mortgage broker business. (i.e. The broker's compensation is maximized when selling the most expensive or less than optimal product to their "client").

So what is a flat fee mortgage?

A flat fee mortgage is when the mortgage broker is a paid a flat fee for their time and expertise. This method allows the mortgage broker to truly find the best and least expensive mortgage for their client. The mortgage broker is paid a flat fee to research, find and execute a mortgage package. These can be done at wholesale rates with NO yield spread and no backend compensation from lenders. The broker quotes a fee for their time and expertise and is paid that fee and nothing more.

What the flat fee mortgage is NOT.

This is not the marketing gimmick by some of the internet lenders using TV advertisements. This is not the $395 or $500 flat fee mortgage. Those loans still have yield spread premiums and junk fees.

The flat fee mortgage we are recommending is as follows:

Fee paid to Broker
$1,500 to $3,000 fee paid to broker - fee is negotiable and depends on loan difficulty but is agreed upon in writing at the beginning of the process. Fee is not based on percentage of loan amount so low loan amounts are now much more attractive to brokers.

Wholesale rates to borrower - No Yield Spread Premium
Offer wholesale rate to borrower - no yield spread, no points on the front end or back end paid back to broker. All rebates or points are given back to borrower in form of lower fee.

No junk fees
3rd party fees are not marked up, no junk fees. All fees are passed through to borrower.

2. Loan Contract -
This is simply a contract that spells out for the borrower what they are committing to pay for the loan and explains the possible outcomes including worst case scenarios for ARM loans. This is badly needed in the industry and will become a requirement either from the industry or from the US government. The loan contract is written so consumer can read and understand the terms, 1 to 2 pages maximum.

How can you get a Flat Fee Mortgage?