(This is Part 4 of a four-part series. See Part 1: Real estate settlement services take bite out of borrowers; Part 2: Eliminating mortgage lender fee surprises and Part 3: Mortgage brokers struggle with consumer distrust.)
The three previous articles in this series advanced proposals for reducing the cost of settlement services provided by third parties, eliminating the escalation of lender junk fees at the closing table, and making mortgage broker compensation transparent to borrowers. This one is about making it possible for borrowers to shop effectively. Shopping is extremely difficult now because mortgages have so many price dimensions.
Even if lenders paid for all the services provided by third parties, which I proposed in the first article, a borrower would have three prices to juggle: interest rate, points, and fixed-dollar fee. (On ARMs, there are more, but I’ll ignore that for now). This is confusing and makes shopping difficult. The solution is to mandate one fixed-dollar fee covering lender and third-party costs.
Mandating a Fixed Fee: If government mandated the same fixed-dollar charge for all lenders and all programs, borrowers would have to shop only rate and points, which is easily manageable. For example, a borrower can shop for the lowest rate at zero points, or the fewest points on a 6 percent loan.
Within reasonable limits, the exact amount of the fixed charge is not important, provided the charge is the same for every lender and every loan. It is the variability in these costs that makes it difficult to shop.
This is price-fixing by government, but in a good cause. When a service carries one price, price-fixing invariably reduces the supply of the service. When a service carries three prices, however, fixing one price merely channels market adjustments into the remaining prices, making it easier for consumers to shop.
A Fixed Fee Would Discourage Predatory Lending: Perhaps the greatest benefit of the one-price rule would be in the sub-prime market, where predatory practices are widespread. Under a fixed-charge rule, these practices become much more difficult to execute.
A common feature of price gouging, for example, is the inclusion of large fees in the loan balance, which borrowers often know nothing about until they get to the closing table. With a fixed-price rule, along with a rule that limits the financing of points, any gouging would have to be in the interest rate, where the potential for snookering the borrower is limited. Even unsophisticated borrowers understand the difference between 7 percent and 12 percent.
In a similar vein, making loans that borrowers can’t repay, or churning loans in successive cash-out refinances, are profitable only if the lender can load heavy fees into the balance. The fixed-charge rule should eliminate both practices.
Enforcement of a Fixed-Fee Rule Would Be Easy: Lawmakers sometimes give little consideration to whether, and at what cost, the rules they promulgate can be enforced. This is certainly true of the existing law against the payment of referral fees, which couldn’t be effectively enforced with an army of examiners. State laws directed at predatory lending that bar loans that “fail to benefit the borrower,” or that “borrowers do not have the capacity to repay,” present similar enforcement problems.
In contrast, the fixed-charge rule would be virtually self-enforcing, because it is unambiguous, and every borrower would be a potential enforcement agent. Borrowers would know what the allowable charge was, and the closing documents would reveal whether the lender was in compliance.
How Much Should the Fixed Fee Be? The fee should not be so high that lenders can make money on the origination process, regardless of what happens later. That encourages abusive practices. Nor should it be so low that early prepayment will cause the lender serious loss because then there won’t be any loans made without prepayment penalties. $3,000 is about right for now. This is the fee set by Innovation Mortgage, a sub-prime lender out of California, which has adopted a one-price rule voluntarily as a marketing tool.
Eliminating Low-Ball Price Quotes: If price quotes can’t be depended on, price shopping goes for naught. Some lenders and brokers routinely offer low-ball price quotes designed to capture the customer, which they retract at the time the price is locked. Because the market is so volatile, borrowers are rarely positioned to contest a loan provider’s statement that market rates increased more, or decreased less, than they did in fact.
Full protection against this common tactic requires a “twin sibling rule.” Lenders must lock at the same rate that they would quote to the borrower’s twin who is shopping the same loan on the lock date. This rule would also be easy to enforce, since loan providers do quote prices to shoppers on the same days that they lock prices to borrowers in process.
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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