Back in 2016, Claudia Robles-Garcia was living in London, working on her doctoral research in economics, when a friend asked for her help in choosing a mortgage.
“My first thought was, sure, I got this,” says Robles-Garcia, now an assistant professor of finance at Stanford Graduate School of Business. But after a month of researching options, she was stumped.
“There are more than 200 products available,” she says, “and they’re incredibly complex.”
By the time she came up with an option, her friend, a first-time home buyer, had already reached out to a mortgage broker — who provided her with a better product than Robles-Garcia had been able to find. In the U.K., over 70% of first-time buyers rely on the services of mortgage brokers. The bewildering array of options — and the prevalence of mortgage brokers — led Robles-Garcia to investigate the role of these middlemen in the home-financing market.
In many quarters, brokers are considered necessary evils. Because they receive commissions from banks, there’s an assumption that their advice is often biased toward products that offer them higher commissions.
“You always hear the worst-case scenarios in the news of borrowers getting ripped off by brokers,” Robles-Garcia says.
Would consumers be better off, she wondered, if brokers were removed from the picture entirely? Are there better ways to regulate brokers, such as restricting the way they get paid? To answer these questions, Robles-Garcia simulated different regulations in a new study.
Contrary to popular belief, she found that both consumers and the mortgage market benefit from the presence of brokers. Their expertise helps home buyers find mortgage products that may not be well advertised. And people tend to return to their brokers for subsequent needs, such as refinancing, which gives brokers an incentive to be honest with their clientele.
A Complicated Coupling
Brokers fulfill an important need because mortgages are unfamiliar territory for the average home buyer, Robles-Garcia says. “A person originates one or maybe two mortgages in their lifetime,” she says. “And the products and contracts are complicated, so first-time buyers might need a bit of handholding from an expert.”
When searching for a mortgage on their own, people often head to the nearest bank branch, or one they use for other services, to learn about available mortgage products. That can create monopolies, Robles-Garcia says, since it means that large banks with more branches are more likely to acquire customers. Brokers, on the other hand, typically carry a portfolio of products from a wide range of banks and can offer a more diverse set of options to borrowers.
To understand how brokers influence the mortgage market, Robles-Garcia used proprietary data from the Financial Conduct Authority in the U.K. on more than 2 million mortgage contracts issued in 2015 and the first half of 2016. She complemented this data with FCA information from broker companies on commissions, broker fees, and other details on the agreements between brokers and lenders. Then, she modeled scenarios where brokers didn’t exist to see how mortgage purchases would change.
“I found that banning broker services from the mortgage market will be detrimental for borrowers,” she says. “Consumers wouldn’t get to hear about a variety of products, and big banks would have more market power in the market.”
Brokers helped small, new banks introduce their products — which were often the cheapest options — to consumers, even though these lenders didn’t have local branches or advertisements and found it hard to reach borrowers directly. Buyers who used brokers were 7% more likely to acquire such products than those who didn’t use brokers. In return, those banks paid, on average, a higher commission to brokers.
On the other hand, she also found that brokers weren’t immune to the financial perks that lenders offered and were more likely to recommend products that would pay them higher commissions. If a lender increased a product’s commission for a given broker by 10%, that product’s market share within the broker’s portfolio would grow by almost 2%.
Despite this trade-off, the overall effect of brokers on the market is positive, and consumers are better off with brokers operating in the U.K. mortgage market, Robles-Garcia says. “The decision should not be whether to ban brokers or not. The question is whether we can change the way brokers get paid to align their incentives with those of consumers.”
Managing the Middlemen
Some consumer advocates have recommended banning commissions for mortgage brokers. Robles-Garcia found that such a ban would actually decrease brokers’ benefits to consumers. Instead, she says, placing a cap on commissions may be a better option. Commissions typically range from 0.1% to 0.9% of a loan amount. Limiting commissions to 0.4%, which is close to the current average, would keep banks from offering substantial perks that might sway brokers’ suggestions to consumers, while at the same time subsidizing financial advice to consumers. “If brokers can’t be paid by banks, then fees to the consumers become higher,” she says. “In a way, banks subsidize this expert advice to consumers. It’s a question of finding the balance that benefits all parties.”
Better data are needed to understand whether the results apply to countries outside the U.K., Robles-Garcia says. While mortgage brokers in the U.K. always receive bank commissions and sometimes charge consumers as well, recent regulations in the U.S. require that brokers be paid by only one party — either the lender or the buyer.
She expects there to be more research by academics and regulators to better understand how brokers affect consumers’ choices and how they interact with banks. The research should apply not only to mortgage markets, but also to other financial markets — stocks, bonds, auto loans, and insurance — where brokers and dealers play a crucial role.