Etiquette around loan refinance - decision is going to cost first broker a lot of commission

Question

We are in the process of doing a refinance. However, we just took out the original mortgage loan recently. The new loan is 3/8 of a point better than the original loan and we are going to save a lot of money in interest payments.

I learned recently that this is going to cost the originator of the first loan quite a bit of money. I feel bad about it, but also, I didn't know at the time I started the refinance that there was a penalty for the originator if I pay off the balance of the first mortgage loan early; no one mentioned this during the process.

Is there etiquette around how I should handle this? Can anyone with knowledge of the loan origination industry explain how much money there is to be gained or lost in an early refinance? The first originator described the loss as "huge" but I don't know if they are exaggerating or what that would entail.

edit according to this answer the penalty may be between 1-3% of the loan value. Does that sound right? https://money.stackexchange.com/a/101707/84070

Answer 1

I have a friend who is a mortgage broker. At the company he works for, if one of his loans is paid off within 6 months of origination, he loses his commission. It's only happened to him a few times in 9 years, and he had to repay the commission on those loans in the form of future paycheck reductions. In his case 2 large loans happened in the same month after rates dropped significantly and he didn't get paid for 60 days. So it definitely can hurt the loan officer that sold you the loan.

I suspect they know this is coming though, as rates have dropped significantly this year.

I would contact your broker, explain the situation and see if they can refi for you. They may have contracts with their banks that don't allow them to, and if they can't then ask your broker what the cutoff date is and if it isn't too far into the future, consider waiting. If you don't want to wait that long, I think you should do what's best for you, but it may be nice to at least let your broker know so they can plan for it accordingly. Of course, you aren't under any obligation to notify them if you aren't comfortable doing so.

Update: regarding your last question, the broker getting a 1-2% commission is certainly plausible (though 3% seems a little high in the current market). You can figure on a 4% loan, in the first 6 months the bank makes just under 2% in interest. It's believable that a bank might be willing to pay the first 6 months of interest to a broker as a finders fee, but only if the loan lasts 6 months.

Answer 2

It's helpful to take a holistic view of this business. OP's link to one of the answer on this site is pretty good albeit brief.

Your lender originates your first mortgage, and then sell it to some financial institutions, who might hold it or package it with other mortgages and sell the pool by pieces (securitized). All these transactions were priced with the market information such as interest rates (and the expectation of future rates) back then.

Now rates have unexpectedly dropped. This raises the value of all the existing mortgages, and benefits the buyers. However, without a prepayment penalty, from your perspective as the mortgagor, you have the option to prepay the mortgage and basically "buy it back" from whoever owns the mortgage now at the face value. (Of course you would fund that purchase with another mortgage, i.e. refinance, at a more favorable rate, and thus at a lower cost).

Essentially this is a call option that moved in the money and it makes all the sense for you to exercise this option. The buyers though certainly wouldn't like it as they are missing the opportunity to make more money (at the then interest rate vs. the currently lower rate). But keep in mind that investors in this business are all sophisticated institutions. They know the embedded options and the risk associated. In fact they often assumes a fixed percentage of mortgage would be prepaid no matter what. So all the "losses" are just a cost of business that they already baked into the assumptions and prices they charge and pay each other.

Still, you can see why lenders would prefer you don't refinance, and can set up the terms to try to steer you away (e.g. prepayment penalty). But I'm not sure how docking the loan officers' pay would help, other than incentivizing them to lie about refinance (as one of the comments pointed out). We see that a lot in car dealership too when they tell people you can't refinance in the first XX days.

But certainly in your case, you shouldn't feel responsible for the awkward position that the lender put their LO in.

Answer 3

The first lender simply gets all their money back when you refinance - where is the "huge loss" in that? Then, they can lend that money to someone else, benefiting from closing costs once again.

So don't feel bad but pay close attention to all the associated costs and penalties, and weigh that against the savings in interest.

Answer 4

I just dealt with the same thing. I think some are misunderstanding the situation. I used a broker to get a fast loan on the perfect home that came out of nowhere. He and his team did a great job and got me a great rate at the time. That was before the 10 year took a nosedive.

It was about 2 months after closing that I was wrapping up the refi. Was going to save me about $175 a month going forward with an 18 month break even.

If I waited 4 more months he would of been in the clear. In that 4 months I’d save $700 if I moved forward.

The broker made about 10k total from the lender which pays him and his team for the work they did. When I found out it would all have to be paid back I decided to pause the process.

He did a great job for us and I feel he earned that money. He was Johnny on the spot for 45 days straight and I’d rather be out the $700 knowing that he got paid for the service he provided me. Plus that’s a lot of money compared to $700.

It was probably an easier choice for us though. Rates are already lower than our refi lock so I’m fairly confident we’ll get a better rate and save more money in the long term by waiting a couple months. Things could go the other way and we might lose a couple bps. Either way, it was the right decision for us to wait, even if it costs us a bit.

But if you think you will miss your window and rates will go higher then you should probably do what makes the most financial sense for you. Not all situations are the same.

These types of things happen in the mortgage business though. Brokers and LO’s know the risks.