(This is Part 1 of a three-part series. See Part 2 and Part 3.)

Because the mortgage market has slowed in recent months, loan providers (lenders and mortgage brokers) find themselves with excess capacity. Rather than go out of business or fire loan officers, many have taken to purchasing mortgage leads.

Mortgage leads are packets of information about consumers who loan providers can hopefully convert into borrowers. Leads have value based on the likelihood of their becoming closed loans. If you were attracted by an ad such as “mortgage rates as low as 1 percent,” and filled out a questionnaire about yourself in response, you are a lead.

The questionnaires ask about the things that matter to a lender in assessing a loan, including income, employment, credit, house price, and loan amount. They also ask for identifying information including telephone numbers and e-mail addresses. The more information given, the more valuable the lead, but lead generators are fearful of asking for so much that the prospect gets discouraged and aborts the process.

Leads Before the Internet

Before the Internet, leads were usually generated by loan providers themselves, poring over public records to find borrowers who might want to refinance. The public records would show homeowners who had mortgages carrying interest rates above the current market. The pitch to the lead was basic and often persuasive. For example, “You have an 8 percent mortgage; I can get you one for 6.5 percent, which will save you X dollars a month.”

When interest rates rose, lead activity largely disappeared. While refinancing for the purpose of raising cash (“cash-out”) continued, there was no easy way to identify in advance the borrowers who might be interested.

Internet-Generated Leads

With the development of the Internet, the lead business changed dramatically. Most leads are now generated not by loan providers, but by lead specialists who may know very little about mortgage lending. When they say, “We don’t care how bad your credit is,” they are telling the truth. They don’t care because they are not the ones who will lend you money. Of course, the loan providers who buy their leads do care.

The leads business has become specialized because the skills required to harvest large numbers of leads at very low cost on the Internet have nothing to do with mortgage lending. The effective lead generators are skilled at developing marketing pitches, at the placement of ads in search engines, and at finding ways to slip their direct e-mail messages past the surveillance of spam filters.

Where leads in the era before the Internet only targeted borrowers who could refinance into a lower rate, now Internet-based leads cover a wide range of possible consumer concerns. For example, consumers with lots of non-mortgage debt might be enticed with “Pay off high-interest credit cards,” or “consolidate into one lower payment.” Consumers struggling to make their mortgage payments might succumb to “Payment options starting at 1 percent.” Borrowers with adjustable-rate mortgages who are worried about rising future payments might be receptive to “Rates are rising, lock in a fixed rate today.” Consumers anxious about their credit may be mollified by “Credit not perfect, no problem,” or “You have been approved up to 577K at 3.92 percent.”

Whether the loan providers to whom the leads are sold will be able to deliver on these promises is wholly irrelevant to the lead generator. The purpose of their message is to generate leads, period. I am reminded of the wonderful ditty by Tom Lehrer about the rocket scientist, Wernher Von Braun: “‘Once the rockets go up, who cares where they come down. That’s not my department,’ says Wernher Von Braun.”

Why You Should Not Respond to Leads

I can envisage a business in mortgage leads where the lead generators certify that the loan providers to whom they sell leads meet certain standards of behavior. That may happen in the future, but it is not the way the leads market works now. Lead generators have no responsibility to borrowers, and offer no warranties about the loan providers to whom they sell leads.

Since the “bad guys” in the industry get few referrals from satisfied customers and business contacts, they are much more dependent on leads than the “good guys.” And that means that consumers who become leads and respond to the loan providers who contact them, face adverse selection. In responding to a solicitation, their chance of getting a predator is greater than if they opened the yellow pages to “mortgages” and threw a dart at the listings.

Next time you are tempted, instead of filling out the form, drop them a note asking what protections they offer against predatory loan providers. But don’t expect an answer.

Next week: Why is it legal to pay for leads but not for referrals?

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.

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