5 truths about mortgage shopping
Selecting a lender before knowing price rarely ends well
By Jack Guttentag, Tuesday, December 27, 2011.
House and interest rates image via Shutterstock.com.Anyone completing a course in microeconomics would find great difficulty applying what he or she learned about competition to the home mortgage market. The market meets the major requirement of a competitive market in having many buyers and many sellers, but the benefits associated with competitive markets are conspicuously lacking. Instead of the expected single price that barely covers the sellers' costs and is available to all buyers, mortgage prices are all over the lot. Some borrowers pay competitive prices, but many pay more.
Why competition doesn't work
The core reason that competition in the home mortgage market doesn't generate the benefits that the textbooks lead us to expect is that most mortgage borrowers are required to select a lender before they know the price. No market will function well under that condition.
Some mortgage borrowers are not aware of this condition, and shop different lenders as if they could make a selection based on price. Most mortgage borrowers, however, don't try to shop; they select or are selected by a single lender, to the dismay of many observers. But the nonshoppers may instinctively realize what many experts have not fully grasped, which is that shopping in this market is largely futile.
I confess that it took awhile before I realized this myself. Over the years, I wrote several articles on "how to shop for a mortgage," which I am now in the process of revising. The corrected title will be more like "how to minimize the loss from having to select a lender without knowing that lender's price."
Why mortgage borrowers can't shop price
Multiple prices: The microeconomics textbooks assume that there is only one price that covers the buyer's payment obligation to the seller in full. In the case of mortgages, however, there are at least two prices: the interest rate and total lender fees. On adjustable-rate mortgages (ARMs) there are also rate caps, the rate index used, and the margin over the index. An interest rate all by itself means very little.
While multiple prices complicate shopping by borrowers, the difficulties would be surmountable if not for the additional problems noted below.
Changeable product: The textbook analysis of competition assumes that the product or service being sold can be precisely defined and doesn't change. If you price a horse but deliver a mule, as in "Fiddler on the Roof," the price doesn't mean anything.
In the case of mortgages, two critical factors affecting the price are not known with certainty until the borrower has selected the lender and applied for the mortgage. These are the credit score and loan-to-value (LTV) ratio, which are determined by the lender based on a credit report and property appraisal ordered by them.
While a preliminary price quote may be based on estimates provided by the borrower, that price is subject to change. Since the financial crisis, such changes have occurred with increasing frequency, and have been larger, in some cases leading to outright rejection.
Uncommitted price quotes: The textbook analysis of competition assumes that buyers can buy at the prices quoted by sellers. In the mortgage market, however, lenders have no obligation to lend at the price they quote until they lock, which may take days or even weeks. In the meantime, the quoted price is very likely to change with the market, which is very volatile. Quoted prices are reset every day and sometimes during the day.
Unsavory lender practices
The inability of borrowers to shop effectively is exploited by some lenders using a variety of unsavory practices.
Lowball scamming is the practice of quoting a price to a borrower below the price the lender is actually willing to accept. The purpose is to be selected by borrowers who believe they can shop price. Lowballing is endemic on Internet-based referral sites, which display price quotes by dozens or hundreds of lenders.
Market-volatility scamming exploits borrowers already onboard but not yet locked by taking advantage of changes in the market. If market prices increase, the borrower is charged the higher price, but if market prices decrease, the borrower is charged the price quoted earlier. In the second case, most borrowers are content to receive the price they were quoted earlier.
Property-valuation scamming exploits borrowers whose loans have been locked before their home appraisal has been received. 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 ratio past a notch point where the price should decrease, the original lock price is retained.
Next week: Regulatory and market-based approaches to eliminating unsavory lender practices.
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.
| Contact Jack Guttentag: | |||
 Email |  Letter to the Editor | ||
All rights reserved. This article may not be used or reproduced in any manner whatsoever, in part or in whole, without written permission of Inman News. Use of this article without permission is a violation of federal copyright law.
You must login or register to post a comment.
Submitted by Danny Currie on December 31, 2011 - 9:13am.
Good article and very true.
I would recommend using leverage in any way possible to start. In any major purchase if you have leverage that supports a vested interest that is not simply a monetary gain than the consumer can truly mitigate the probability of not receiving the best value proposition.
If the consumer uses the resources available to them and chooses the loan officer to close their loan instead of an institution the experience is significantly different and more often than not the client walks away with the best overall experience and value.
I use the principle of leverage in my business daily to support earning the trust, connection, and rapport necessary to ensure that the commitment of the client is as strong as my commitment to them. In doing so this, supports less fall out of clients and higher closing ratios and finally a win win for everyone involved.
You are completely correct in that the way consumers are conditioned to shop for a mortgage is flawed to the say the least. I can say that it's more often than not that I get consumers who shop and make an effort to compare however, due to the new regulations it doesn't allow them too.
This leaves the best overall solution which is choosing a person to do your loan and not a company. Given that 99% of the time a loan does not close on time or even at all in some cases it's the loan officer's fault, it's more important to establish some sort of leverage in the transaction given there is absolutely no accountability in our industry for the losses associated with a company's inability to execute properly.
Due to the lack of accountability in our industry this is precisely the reason that the only way to shop for a loan is through leverage because it's the only way to create a vested interest between the loan officer and the client that doesn't only rely on the monetary result of funding the loan.
If the consumer chooses an institution, rate, and or price before the actual person responsible for executing the loan than it's significantly more likely for the end result to be less than satisfying not to mention much more stressful. It's not that company, price, and rate are not important it's simply that those issues more often than not are easy to overcome.
If the consumer chooses the loan officer based on the opportunity to build trust, connection, and rapport based on a model that is increasing at an increasing rate than it opens the door for an opportunity to ensure that the client will get the best value overall. As you are probably aware the margins on the "front" end of loans are significantly lower than the "back" end or servicing of the file. However, consumers don't understand this or even think about this because they are not conditioned to.
Once you begin to discuss this with them they get it immediately. This is important because this means that more often than not that the retail banks along with brokers and correspondents are going to be very close in price and rate. Due to the majority of loans being fully docked loans, an average consumer with average scores and other qualifying requirements will otherwise receive quotes from many banks all within the same range.
There is not going to be a major variance among them enough to completely eliminate them. If there is you have enough to review and discard accordingly. More importantly, since the client made the decision to choose a "loan officer" first then the client can simply take all the quotes they received and bring the lowest one to review and at the very least match it.
At that point the client has chosen the person ultimately responsible for funding the loan and more than likely the only one with any other accountability to them the opportunity to match what the consumer found to be the lowest price available in conjunction with the loan officer that they have the most leverage over. It is very very rare to have a client come in with something so low that a company will not match it and more importantly, the company doesn't want to lose the client that they have invested so much in. If for some reason the company can't match it because it is a significant cut in price than the best thing the loan officer can do is let the client know they must call that bank and lock the loan immediately.
This is critical because it now puts the validity of a quote in question. If we see quotes that are way out of line we know it because we know that it's highly unlikely that a bank is going to honor it. So the best way to force the hand of the quotes legitimacy is to immediately request a lock. If the client gets anything other than lock confirmation from them than something isn't right. We do this because it prevents other loan officers from quoting rates that they know they will not have to honor until days or weeks later. What happens most of the time is the loan officer who quoted the rate and price will have to go to a manager to get an exception and once they see the significant cut in rate they will more than likely say no and then the excuses start.
When this happens, then the reality comes back to the client and the value of my relationship with them increases and in the end that's the goal. If the other institution is willing to lock the rate than great! I still win because I am directly responsible for that client getting the best price on the loan. It's always a win win....
Sorry for being so long winded I could talk for days.....sometimes I wish I could get paid for simply teaching consumers how to shop for a loan. I have saved so much money for clients over the years not to mention stress.....
Great article!