Editor’s note: This is the first of a two-part series.
Shopping for the best deal on a home loan has many pitfalls, but by far the most daunting is that lenders will not commit to the prices they quote to shopping borrowers. While borrowers seldom realize it when they begin the process, the fact is that they are forced to select loan providers without knowing the exact price they will pay.
Why quoted prices are subject to revision
Because locking imposes a cost on lenders, they won’t lock until a) they have enough information about the borrower to be reasonably sure that the borrower qualifies and that the price quoted is the correct price, and b) there is a significant probability that the borrower will go to closing. If the quoted price that is locked by the lender is wrong, the lender can realize a loss when it is sold, and if the transaction doesn’t close, the lender has incurred the lock cost for nothing.
The quoted price can be wrong for two reasons: One is that the information provided by the borrower does not check out for the lender. For example, the borrower said that his credit score was 740 but when checked by the lender it is 710, which raises the price of the mortgage.
The quoted price can also be wrong because the market changed. Lenders reset prices every morning, based on changes in the secondary market, and sometimes they change them during the day.
Why the revision of quoted prices may be a scam
Changes in market prices or a reset of the information used to set prices are legitimate reasons why borrowers often don’t receive the prices they were quoted. But these same factors provide a screen behind which less scrupulous lenders can execute lock scams. It is useful to distinguish three scams that occur at different stages of the lending process.
Lowballing scam: The borrower shopping for a mortgage may encounter this scam. Lowballing lenders quote a price below the price the lender can or has any intention of delivering. The purpose is to be selected by the borrower who is shopping prices. It is easy to lowball when you are not committed to your price quote, and it is tempting because it often is the only way that lenders have of distinguishing themselves from other lenders.
Lowballers are not deterred by the price disclosures mandated by the good faith estimate. They merely date the disclosure so that the price has expired before the borrower receives it.
Market volatility scam: The borrower who has selected a lender but has not yet been locked may encounter this scam. The lender takes advantage of changes in the market between the date the lender quoted a price to the borrower and the lock date. If the market price goes down, the borrower is charged the price quoted earlier, and is probably content, since he received what he was quoted. If the price on the lock date is higher, on the other hand, the borrower will be charged the market price or higher, because "the market went against you."
Property valuation scam: The borrower whose loan has been locked may encounter this scam. Locks are always contingent on a specified credit score and loan-to-value ratio. A material change in one of these can invalidate the lock. While lenders will always verify the credit score before locking because that takes only minutes, in most cases they will lock based on a property valuation that has been checked against only an automated valuation program. An appraisal, which is the final word on valuation, takes days and often weeks.
Nonetheless, the appraisal, when it becomes available, can invalidate the lock. If the appraisal comes in lower by enough to raise the loan-to-value ratio past a notch point where the price increases, the lender increases the price accordingly. But if the appraisal comes in higher by enough to reduce the loan-to-value past a notch point where the price should decrease, the original lock price is retained.
As with the market volatility scam, if the coin comes up heads, the borrower loses; and if it comes up tails, the lender wins.
None of the mortgage disclosures mandated by the government would prevent the scams described above. This includes the disclosures planned by the new Consumer Financial Protection Bureau. Borrowers can protect themselves, however, if they know how to go about it. This will be the topic of next week’s article.
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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