Editor’s note: This is Part 3 of a five-part series.
The previous article in this series on certified lender networks described how such networks will provide competitive loan pricing. This article describes how the networks will provide competitive pricing of the third-party services and settlements that are required accessories to home mortgage loans. In some respects, this is an even greater challenge.
Third-party services are overpriced
Every consumer taking a home mortgage today pays a private tax in the form of unnecessary charges for the various third-party services required to deliver the mortgage. These includes services provided by title insurance companies, mortgage insurance companies, appraisers, credit reporting agencies, flood insurance companies, escrow companies and others.
The taxes are paid to those who are positioned to refer borrowers to specific service providers. These referral agents are mainly lenders, but some are Realtors and builders. The payments include referral fees, which are sometimes legal and sometimes illegal. Some of the tax is absorbed by the high marketing expenses incurred by service providers soliciting the business of referral agents.
The problem is not that there isn’t competition in these industries — the competition is actually intense, but it is directed to referral agents rather than to the consumers who pay for the service. Competition directed to referral agents drives prices to the consumer up rather than down, since most agents are more interested in being paid for the referral than in negotiating lower prices for consumers.
The source of referral power
Why don’t borrowers select their own service providers? The major reason is that their focus is on their primary needs, which is the home purchase and the loan. The path of least resistance, which most take, is to allow their major contact to handle the incidentals. This is what gives lenders, Realtors and builders their referral power.
The case of private mortgage insurance
Consider mortgage insurance as an example. Under existing arrangements, the lender selects the carrier — the borrower is never consulted, even though the borrower pays the premium. If there is another carrier offering the same policy for a lower premium the borrower does not know about it and the lender does not care. The insurer selected is the one providing the most valuable set of services to the lender, not the one offering the lowest premium to the borrower.
Mortgage insurers also offer multiple premium plans, including monthly premiums and single financed premiums. One or the other may be least costly to a borrower, depending on how long she expects to have the mortgage, her tax rate and her opportunity cost — how much she earns on her investments. Very few lenders offer borrowers their choice of premium plans, and none offer the decision support that should go along with it. It is a bother and takes too much time.
Third-party services on the network
The network, in contrast, instead of locking the borrower into a decision made by the lender, will provide competitive options. It will allow third-party service providers to price and market their services directly to borrowers through the network. Marketing expenses of service providers will be far lower than those involved in marketing to lenders, who look for free or low-price services as quid pro quo for their referrals. The combination of lower marketing expenses and price competition will reduce prices to borrowers.
The network will also offer decision support in connection with the selection of the best mortgage program and the best combination of interest rate and points. In the case of mortgage insurance, it will offer borrowers the capacity to compare the all-in costs of alternative premium plans. Decision support is discussed further next week.
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.
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