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Reader question: “We are planning to buy a house sometime during the first part of 2014. It’s been years since I’ve been through the mortgage process. I’m wondering what the advantages are to using a mortgage broker when shopping for a loan, as opposed to going straight to a bank lender. From what I’ve read, some things have changed in the lending industry with regards to brokers and how they are compensated. Should I use a mortgage broker or a bank in 2014? What are the pros and cons of each?”

While the rules for compensation will soon change, the benefits of using a mortgage broker will remain the same. By working with an experience broker, you’ll have access to a broader range of loan programs and products. If you go directly to a bank / lender, you will be limited to the products that particular lender is offering at that particular time.

What Is a Mortgage Broker? What Do They Do?

So what is a mortgage broker, exactly? A broker is basically a middleman between (A) the lender that provides the funds, and (B) the borrower who uses the funds to buy or refinance a home. So the lender is the one who actually gives you money on closing day. They are the bank, so to speak.

You can think of the broker as a matchmaker of sorts. This individual does not actually lend money to the borrower. Instead, he or she attempts to find a loan that meets the borrower’s needs. In doing so, he has generated a new customer for the bank / lender, and a commission for himself.

The broker does not actually work for a mortgage company, but is more of an independent contractor who offers products from multiple lenders (called wholesalers).

Advantages of Using a Broker: Updated for 2014

Should you use a mortgage broker or bank lender in 2014? Once you consider the advantages and disadvantages below, you’ll have an easier time deciding.

The biggest advantage to using a mortgage broker is that it gives you more options, in terms of home loans. The broker will review your financial situation (credit score, income, debt, etc.) and try to match you with a lender that can meet your needs. This is the primary advantage of working with a mortgage broker, as opposed to going straight to a bank / lender. You’ll have more loan options and programs to choose from, because the “matchmaker” will be able to choose from a pool of lenders — sometimes dozens of them.

Another advantage of using a mortgage broker is that they often specialize in “niche” products and programs. For example, a broker might specialize in finding home loans for borrowers with marginal credit scores (the kind of score that some lenders turn away). Some specialize in government-backed loans, such as the FHA and VA programs. So if you’re looking for a specific type of product, you might consider working with a broker who specializes in that product.

Possible Disadvantages

There are some possible disadvantages to using a mortgage broker. One disadvantage is that the broker will likely remove himself from the picture once the “match” has been made. So the person you got to know in the beginning of the process might not be around to guide you through the entire process. You’ll have a whole new point of contact, once the mortgage broker finds you a lender.

There is also the broker’s fee to consider. You need to know who pays this fee, because it varies. In some cases, the mortgage broker gets paid on the front end, in the form of an origination fee that is charged to the borrower. They can also be compensated by the bank or lender, on the “back end” of the process. Just be sure to ask plenty of questions, so you know how — and by whom — the broker is getting paid. (See the compensation section below for an update on how this is changing in 2014).

There’s also a chance the broker will steer you into a loan that is best for him, in terms of the commission earned, but not necessarily best for you. In the past, this used be to a major disadvantage / downside to working with a mortgage broker. These individuals would often steer borrowers into high-cost loans, in order to generate bigger commissions for themselves. But this is actually less of a concern today. Starting in 2014, new rules on compensation will prevent this sort of “steering incentive.” See the compensation section below for more on this.

Should You Go Straight to the Bank?

Are you currently a member of a bank or credit union that also provides home loans? Perhaps you have a checking and/or savings account with a financial institution that offers mortgage financing? If so, you might want to consider skipping the broker and going straight to your bank.

There are potential advantages to this strategy. For instance, if you are a long-time customer of a state or local bank that also provides mortgage loans, they might offer you favorable pricing and terms. They might waive certain fees, or offer you a lower interest rate than you could find elsewhere. Banks and credit unions typically strive to create more value per customer. This means offering additional products to existing customers, often with some kind of incentive or “good deal” for the customer. It’s something to consider.

New Rules on Compensation Will Protect Consumers

We’ve covered the first question: Should I use a mortgage broker or a bank in 2014? Let’s move on to talk about some forthcoming changes to broker compensation, and what they might mean to you as a borrower.

During the housing boom, and even in the years leading up to it, unethical loan originators frequently steered home buyers toward riskier and higher-priced loans. They did this to generate a higher commission for themselves. Both the Federal Reserve and the federal government have since taken steps to prevent this kind of incentive-based loan steering.

In January 2014, a new set of rules will regulate the way mortgage brokers (and other loan originators) are compensated by banks and lenders. These rules were mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, and finalized by the Consumer Financial Protection Bureau (CFPB).

Here are two key provisions you should know about, as a consumer:

  • No more “steering” incentives: When the new rules take effect in January 2014, they will prohibit lenders from connecting the broker’s compensation to the loan terms. As the CFPB explains, “a mortgage broker or loan officer cannot get paid more if the consumer takes a loan with a higher interest rate, a prepayment penalty, or higher fees.”
  • No more “dual compensation”: The forthcoming rules also prohibit dual-compensation scenarios, where the broker gets paid by both the consumer and the lender.

The Federal Reserve summed up the new rules this way:

“The rule prohibits a creditor or any other person from paying, directly or indirectly, compensation to a mortgage broker or any other loan originator that is based on a mortgage transaction’s terms or conditions, except the amount of credit extended. The rule also prohibits any person from paying compensation to a loan originator for a particular transaction if the consumer pays the loan originator’s compensation directly.”

This relates back to the original question: Should you use a mortgage broker, or go directly to a bank lender in 2014? If you choose the former, you’ll be glad to know these new rules on compensation are designed to protect you, the consumer. Once they take effect, borrowers who choose to work with brokers will have more protection under the law. Loan originators will no longer have an incentive to steer borrowers toward home loans with higher interest rates or fees, or loans with pre-payment penalties.