Be Loyal & Don’t Shop: A Recipe for Overpaying

Big banks love mortgage consumers who don’t carefully comparison shop.

They also enjoy capitalizing on their “home bank” advantage with existing customers.

“Search costs” refer to the time, skill, money and effort required to find a better mortgage deal. “Switching costs” represent the expense of moving to a new lender.

The article that follows examines recently-released research on these topics. It’s a revealing look at how big lenders benefit significantly from things like mortgage “search costs” and customer “switching costs.”

The findings below come from a brilliant Bank of Canada research paper by Jason Allen, Robert Clark and Jean-François Houde. It’s chock full of insights into why mortgage consumers pay higher rates than they have to, and why being loyal to a lender can cost you.

The key findings of this research are summarized below. If you don’t have time to read them all, focus on the highlighted parts. CMT comments appear initalicized text and after the “Observations” labels. All quotes are taken directly from the study.

Consumers aren’t created equal:

  • Research shows that there are major differences in people’s:
    • “Degree of loyalty to their main financial institution.”
    • Ability to “understand the subtleties of financial contracts”
    • Ability and willingness to “negotiate and search for multiple quotes”
  • Canadians generally don’t consider all available mortgage alternatives.

Hunting for a better mortgage:

  • Many borrowers simply do not work as hard to “search” for a better mortgage. That’s largely because of the effort they “must put forth when gathering multiple quotes.”
  • Inadequate mortgage research induces “profits for lenders” and “permit(s) them to price discriminate between consumers.” (It also raises your chances of getting stuck with bad mortgage terms.)
  • “The average markup is estimated to be 4.1% for non-searchers and 1.9% for searchers, but the distribution is much more skewed for searchers with close to 25% of [comparison shoppers] facing zero markup (above the marginal cost).”
  • In the past, “approximately 25% of borrowers [paid] the posted rate.” (This was based on data from more than a decade ago. The numbers are not as high now, especially for well-qualified borrowers. That said, there is no data to confirm how many people actually pay the posted rate today.)
  • “…Consumers dealing with [large] institutions pay more on average for their mortgage.”
  • Not surprisingly, the decision to switch lenders is “correlated with” the borrower’s willingness and ability to search for a better deal.
  • “The fraction of ‘switchers’ is significantly larger” for:
    • New homebuyers (i.e., former renters or [those] living with their parents), and for
    • Broker customers (Lenders love to get their hands on first-time buyers, and it’s a big reason many are happy to pay brokers to deliver those customers.)
  • “Consumers financing larger loans…are more likely to search (and pay lower rates).” In turn, they have a higher “switching probability.”
  • “Richer households have a higher value of time, and therefore higher search costs on average.” (…and many of them needlessly overpay.) In short, they have less tendency to switch lenders.
  • “…About 30% of consumers only consider dominant lenders.” (Usually a big mistake.) “For these consumers, the average number of lenders drops to three, which can significantly increase the profit margin of banks.”

“Home Bank” advantage:

  • Everything else equal, a customer’s home bank usually gets their mortgage business. This is akin to a home field advantage in sports. (“Home bank” can also refer to a client’s “home lender.”)
  • Even when all is not equal, the home bank often wins. That’s partly because consumers are “motivated by more than just price.”
  • The study’s authors estimate that consumers are willing to pay “between $759 and $1,617 upfront($13.80-$29.40 per month) to avoid having to switch banks.” (Many will pay more because they can’t quantify the value of lender differences. Case in point are mortgage penalties, which most people can’t measure until it’s too late—when they have no choice but to break their mortgage and pay whatever they’re quoted.)
  • Put another way, “lenders directly competing with [a client’s] home-bank will on average have to discount the [mortgage] by a margin equal to the switching cost in order to attract” a new customer.
  • The study finds that “loyal consumers pay on average nearly 9 basis points above the rate paid by switchers.” (It’s no coincidence that many borrowers choose to stay with their existing lender when a competitor’s rate is better by less than 10 basis points.)
  • Not surprisingly, “the market for ‘non-loyal’ consumers is very competitive”
  • Factors that support customer loyalty to their home bank include:
    • Proximity to a local branch
    • Better access to lending terms
    • Association with a strong recognizable brand
    • Consolidation of accounts (for convenience)
    • Lower chequing account fees, higher savings rates and other perks (Bank and credit union reps commonly use these perks to counter customer objections to higher mortgage rates. To some extent, free banking, banking comparison sites and modern-day electronic funds transfers are reducing the allure of these home lender “freebies.”)
    • The cost and effort of switching bank accounts to a new lender (It isn’t necessary to have your mortgage and bank accounts at the same lender, but some people believe it’s important.)
  • Observation: The data used in this study is 11-13 years old. There is no way to know how much the home lender advantage has changed in that time. Various factors have altered this advantage over the last decade, including:
    • Rate comparison sites — which make it easier to know when your lender isn’t being competitive
    • More broker competition — Brokers reduce consumers’ search costs by assisting them with comparison shopping and offering comprehensive advice not biased to one lender. (Although, it should be noted that in most cases 90% of a broker’s volume is routed to three lenders, so there can be bias there as well.) “Unlike in the United States, brokers in Canada have fiduciary duties…The average discount that a mortgage broker can obtain for a borrower is about 20 basis points, or approximately $16 per month on a $140,000 loan.” (It’s likely lower now as this data is old.)
    • Electronic banking — Many consumers want a mortgage that’s integrated with their banking. That plays right into the hands of deposit-taking lenders. Today, however, one can link different institutions’ mortgage accounts and bank accounts and electronically move funds between them with ease.
  • “In 2004, 80% of new borrowers…contacted their main financial institution when shopping for their mortgage.”
  • The research shows that, depending on the year, “nearly 60% of new home-buyers remained loyal to their main institution.” (CMHC’s Mortgage Consumer Survey finds that 88% of renewers remain loyal to their existing lender.)
  • “…Only 35% of consumers dealing with brokers remain loyal to their home institution”
  • 73% of households choose a lender with which they already have a prior financial relationship. The study authors estimate that “72% of consumers have a positive home (bank) bias.”
  • “67% of Canadian households have their mortgage at the same financial institution as their main checking account.” (Having your bank account gives a bank an enormous advantage. Some have even been known to scan customer chequing accounts to see if they’re making a mortgage payment to another lender. The bank then contacts them ”out of the blue” to solicit their mortgage business.)
  • Banks are more likely to transact with customers who are not motivated to search as hard. (These customers are low-hanging fruit for the banks.)

Home bank tactics:

  • “Lenders…are open to haggling with consumers based on their outside options.” (We all know that, right?)
  • “This practice allows the home bank to price discriminate by offering up to two quotes to the same consumer: (i) an initial quote, and (ii) a competitive quote if the first one is rejected.” (Savvy well-qualified consumers routinely reject their lender’s first quote.)
  • Lenders know that “low risk and wealthy consumers represent lower lending costs.” For that reason, lenders offer “lower rates on average” to these borrowers.
  • “The loan sizes and credit scores of consumers are particularly strong predictors” of the rates they pay.
  • Lenders know financially constrained consumers have fewer options. These people “pay on average a premium equal to 14 basis points.”


Lisa Manwaring, AMP/President
The Mortgage Alliance Company of Canada
Meridian Southwest Mortgage
P: 604 943-8943      F: 604 943-8942

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