Few mortgage borrowers shop alternative loan providers, despite the extensive system of mandated disclosures that are supposed to help them do exactly that.
The problem is that existing disclosures under Truth in Lending and the Real Estate Settlement Procedures Act need not be provided until three days after the lender receives a loan application, at which point the borrower is already heavily invested in the transaction.
For most, it is then too late to shop.
Regulators are aware of this and have been flirting with the idea of mandating some new disclosures that lenders must provide at or prior to the submission of loan applications.
I critiqued a proposal of this sort by the Federal Reserve in 2009 and concluded that the disclosures proposed by the Fed would provide no help to shopping borrowers because they would be answered in the same way by every lender.
On Dec. 6, 2010, the Treasury Department held a symposium on the same topic. Participants were invited to contribute a sample form that "can be used for shopping for a mortgage loan before application" (my italics). Nine proposed disclosure forms were distributed at the symposium.
After examining the proposals, I concluded that none of them, or any combination of them, would help borrowers shop for the best price.
For one thing, a lender cannot provide a borrower with accurate prices unless the borrower first provides the lender with the information the lender needs to price accurately. This includes property type and location, the borrower’s occupancy intention, down payment, credit score, credit history, debts, income and employment.
None of the proposed disclosures would provide any of this information to lenders.
When lenders do not have the information necessary to price a loan accurately, they price for AAA deals — those commanding the lowest prices. In today’s market, the lowest prices might apply to 5-10 percent of borrowers. For the rest, information on AAA prices is inaccurate and potentially misleading.
A second reason the proposed mandated disclosures would not help is that even when lenders have all the information they need to price accurately, usually they can’t be held to their quoted prices.
Prices are not firm until they are locked, and lenders will not lock the price of a shopping borrower prior to the borrower making application. Locking is costly, and before incurring the cost the lender wants some indication that the shopper will become a borrower.
The only way a shopping borrower can obtain a firm quote is to apply on the spot and have the lender lock the price before prices are reset. Insiders tell me that no more than a third of all mortgage borrowers today are able to lock the price they are quoted when they apply.
The others must wait until some of their information, often their property value, has been verified. This takes days, sometimes weeks, during which the market changes.
If a borrower selects the lender who quotes the lowest price but cannot lock that price, the prior shopping was wasted effort. The locked price is the only price that matters and once the lender is selected, that price can’t be shopped — it is what the lender says it is on the lock day, constrained only by the lender’s integrity. Abuses are widespread.
The third problem the proposed disclosures did not address is that the all-in price of a mortgage includes upfront fees for services provided by third parties, such as title insurers and appraisers, which lenders can only estimate.
Treasury asked symposium participants to include the total of these fees in the disclosures, but unless lenders guarantee these fees, their inclusion can be misleading. It generates an incentive for lenders to "lowball" the estimate so that their total appears attractive to the borrower relative to the totals disclosed by other lenders.
Bottom line: To price-shop effectively, lenders must be provided with all the information required to price accurately; borrowers must be protected against locking abuses; and prices of third-party services must be locked as well as loan prices. There is no set of mandated pre-application disclosures that would meet all these requirements.
But mandatory disclosures are not the only game in town. There is a way to assure competitive prices for both the mortgage and third-party services. Next week, I’ll offer the first in a series of articles on how to do that.