(This is Part 1 of a two-part series. Read Part 2, "Seattle mortgage broker adopts U.K. model.")

To gain perspective on institutional practices, nothing beats seeing how the practices differ somewhere else. Recently I looked at how mortgage brokers and the lenders they deal with operate in the United Kingdom. I have had invaluable help from Richard Hobson, a broker in the U.K. for many years who is now a broker in the United States.

The basic economics of the industry are essentially the same on both sides of the Atlantic. Assuming that the lender is satisfied that the broker is properly licensed or certified, the arrangement between them is very simple. In effect, the lender says to the broker: "Here are my prices and eligibility requirements; you bring me an eligible customer and I’ll make the loan."

Lenders find it advantageous to work through brokers because it gives them nationwide distribution capacity without branches or loan officer employees. Even a single-office lender can offer loans wherever there are brokers with whom it can do business. Lending through brokers is flexible; the lender who wants to cut its loan volume simply prices a little higher so the loans stop coming. It isn’t necessary to fire anyone or close offices.

On the broker side, mortgage brokerage is an attractive occupation for energetic self-starters who like to be their own bosses and reap the full rewards of their own efforts. They must be capable of meeting the legal requirements, which are generally low in the U.S. and higher in the U.K., as I’ll discuss next week. If the opportunities are provided by lenders, there is never a shortage of brokers.

Yet mortgage brokerage practices in the U.K. evolved differently than in the U.S. Perhaps the most important difference is that the pricing of broker services is much more transparent in the U.K. This greater transparency is closely related to differences in the way that lenders price mortgages.

A major consequence of the difference in transparency is that many brokers in the U.S. engage in opportunistic pricing, adjusting their markups to what they believe they can induce the borrower to pay. There is no opportunity for this in the U.K. The average markup in the U.S. is more than 2 percent, which is at least twice as large as in the U.K.

U.K. brokers perform the same functions as U.S. brokers, and they are burdened with regulatory duties that U.S. brokers don’t have, which I will discuss next week. U.S. brokers may work as hard per dollar of income, however, because they spend so much time on transactions that never close, and therefore don’t generate any income. Lack of transparency generates distrust, and distrust causes many borrowers to try to protect themselves by flitting from one broker to another, or by trying to play one broker off against another.

Next week: Differences in the way brokers are regulated in the two countries.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

***

What’s your opinion? Leave your comments below or send a letter to the editor. To contact the writer, click the byline at the top of the story.

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