Jack M. Guttentag The Mortgage Professor

I want to be an Upfront Mortgage Broker because I already do business the UMB way. I'm concerned, however, with the part of the UMB Commitment, which states that "the broker will be the customer's representative or agent."

The model broker disclosure form of the National Association of Mortgage Brokers states that "in connection with this mortgage loan we are acting as an independent contractor and not as your agent."

Aren't these two things at odds with each other?

Independent Contractor vs. Agency

The mortgage broker trade associations have always promoted the independent contractor model and warned against the agency model, because the agency model opens the broker to claims of violation of fiduciary duty.

If you want to be a UMB, however, you must operate as if you're the borrower's agent, and accept the obligations that come with it. Obligation No. 1 is "The broker will endeavor to act in the best interests of the customer."

The independent contractor model views brokers as similar to merchants who buy at one price and sell at another price. They can earn as much on transactions as they can induce borrowers to pay, need not disclose what they make except where required by law, and have no obligation to deliver the mortgages best suited to borrowers’ needs.

The agency model, in contrast, accepts that brokers are service providers, not merchants, and they negotiate fees with clients upfront. Their services include finding mortgages that best meet borrowers’ needs.

The agency model is in its infancy. The independent contractor model dominates the industry, and prevailing industry practices reflect that dominance.

Independent Contractors and Industry Practices

Most brokers charge what the market will bear. This means that unsophisticated borrowers who accept what they're told and visit a single broker will pay more than knowledgeable borrowers who challenge the broker and shop for alternative sources. There's very little relationship, therefore, between broker charges and the amount of work the broker does for the borrower.

Broker charges average over 2 percent of loan amounts, which is about twice as high as they should be. A major reason for high fees is low productivity. Brokers spend an inordinate amount of time looking for clients, pay heavily for leads from an industry of lead generators, and waste time with potential clients who don’t close. Low productivity generates pressure to earn more on the deals that do close.

A major reason for low productivity is distrust, which pervades the letters I receive from borrowers concerning brokers. A broker who's an independent contractor has the right to make as much money as possible from a complex transaction that the broker understands and the borrower doesn’t. How can that not breed distrust?

Brokers detest borrowers who flit from broker to broker, submit multiple applications, or pump brokers for information and then deal elsewhere. Yet these practices are how borrowers try to protect themselves against brokers they don’t trust. Borrower reactions to distrust raise broker costs, which pressures brokers to make more per transaction, which generates more distrust in a vicious circle.

The Upfront Mortgage Broker Approach

Upfront Mortgage Brokers (UMBs) operate according to a different set of rules than the remainder of the industry. UMBs view themselves as the agent of the borrower, to whom they owe a fiduciary responsibility. A UMB agrees with the borrower on total broker compensation from the transaction, and passes through the best price from the broker’s lenders.

The agency approach recognizes that shopping mortgages is difficult for borrowers, but that brokers are experts at it. The optimal arrangement for many borrowers, therefore, is to purchase the shopping expertise of brokers for a fixed fee.

The advantage of the UMB approach is that it breeds confidence, which lowers costs and increases productivity. I know UMBs who charge half the industry average per transaction but close three to four times as many loans. Their secret is a continuous stream of referrals from previous clients -- and from me.

Legal Hassles Over Agency

While UMBs view themselves as agents of the borrower, they don't make an explicit declaration to that effect. Some UMBs work for broker firms that fear the legal liability that goes with agency relationships, and some wholesale lenders require brokers to declare themselves as independent contractors.

In grappling with this issue, the officers of the Upfront Mortgage Brokers Association (UMBA), the trade group of UMBs, and I, agreed to eliminate the use of the word "agency" in the UMB commitment. However, the new wording of the commitment makes it perfectly clear that UMBs are required to operate as if they are agents of the borrower, regardless of how the law interprets their actions.

Implementation of the Agency Approach

The way to break the circle of distrust is to change the operating model, from independent contractor to agency. The government should but probably won’t mandate the agency approach because it would be opposed not only by the broker associations, but also by the wholesale lenders, who are as short-sighted as the brokers.

They support the independent contractor model in order to limit their own liability for broker misdeeds. The agency approach will have to win the battle in the marketplace, which will take some time.