“I have heard that it is easier to shop for a refinance than for a purchase mortgage, but I’m not completely sure why…?”

Borrowers purchasing a house are faced with a closing date on which they must provide funding to complete the purchase. This means that at some point in the process there is not enough time for the purchaser to back out of a deal and start anew with another loan provider. Once past that point, they are at the mercy of the loan provider.

Purchasers who haven’t locked the price of the loan by that time are particularly vulnerable. The loan provider promises to lock “at the market price” on the day the purchaser elects to lock, but the market price is what the loan provider says it is. If he cheats, too bad, the borrower is stuck.

Even if the purchaser has locked, only the rate and points are covered. (Points are an upfront charge expressed as a percent of the loan). Neither lender fees expressed in dollars nor third-party settlement charges are covered by locks, and there are many ways to increase them when the borrower has no place to go.

In contrast, the refinancing borrower who feels badly treated by a loan provider can opt out of the deal at any point and start again with another loan provider. Most borrowers can refinance anytime.

Indeed, a borrower refinancing with any lender other than his/her current lender can go to closing, then exercise a right of rescission under the Truth in Lending Act. This gives borrowers three business days to inform lenders in writing that they have changed their minds. The lender must then return all fees and remove any liens on their property. This right is not granted to loans used to purchase or construct a house.

The right of rescission was designed to protect refinancing borrowers against solicitations by sweet-talking loan providers. It applies regardless of the kind of property that secures the loan, so long as it is a residence, or whether or not the refinance is “cash-out.”

The right of rescission does not apply to refinancing with the current lender, presumably because that lender has less incentive to deceive the borrower into taking a bad loan. The right of rescission also does not apply if the property is a second home or an investment, presumably because lawmakers felt that such borrowers ought to stand on their own feet.

The three-day period begins on midnight of the day in which all the required loan documents have been disclosed and signed. If this happens on a Wednesday, the right expires at midnight Saturday (Saturday is considered a business day). If the papers are signed on Thursday, the right expires at midnight Monday, since Sunday is not a business day. If the papers had been signed on Thursday, Dec. 23, 2004, the right would expire at midnight Tuesday because Saturday is Christmas.

Refinancing borrowers have one other advantage. It is much easier for them than for borrowers purchasing a house to use a no-cost-mortgage-shopping strategy. Under such a strategy, the lender becomes responsible for settlement costs, so the borrower can focus entirely on the interest rate. This simplifies shopping enormously. Lenders who agree to pay the costs have no opportunity to raise costs later in the process.

On refinancings, no-cost loans are widely available because many lenders are prepared to assume full responsibility for settlement costs. Most of the settlement costs on a refinance are lender fees, and the third-party services that generate charges (such as appraisal or credit) are often waived. Guaranteeing settlement costs involves little risk.

On home purchases, in contrast, lenders will not guarantee settlement costs. Home purchases involve a number of third-party charges that lenders may have difficulty in pricing. The only lender who will guarantee settlement costs on a home purchase is ABN AMRO at www.mortgage.com.

“Is there any way that mortgage shopping to purchase could be made as easy as shopping to refinance?”

Borrowers can’t be given the right to rescind a purchase mortgage because that would mean rescinding the purchase. But shopping for a purchase mortgage could be made just as easy as shopping for a refinance.

This could be done by enacting a rule that lenders could charge borrowers up to some fixed amount, say $1,500, but have to absorb all other costs, including third-party charges, themselves. With this rule in place, mortgages would carry one price, the interest rate, and borrowers could shop rates without worrying about other charges. You will hear more about this idea in the months to come.

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.


What’s your opinion? Send your Letter to the Editor to opinion@inman.com.

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