(This is Part 2 of a two-part series. Read Part 1.)
“I am choosing between a loan from an Internet lender and one from a well-known bank. The loan officer at the bank made the following claims regarding online lenders: First, their loan officers are not commissioned, and therefore their service is generally poor. Second, Internet lenders sell all their loans, so borrowers don’t know what lender will service their loans. Third, Internet lenders don’t stand by their rate locks.”
Let’s take the issues one at a time.
Does the compensation system used by major lenders result in better service to borrowers? Loan officers (LOs) working for name lenders, such WaMu, Citibank and GMAC, are commissioned, and successful ones make a lot of money. They are highly paid because they bring in the borrowers. Commissioned loan officers constitute the marketing muscle of the major retail lenders.
In contrast, LOs working for Internet lenders, such as E-Loan and Amerisave, don’t bring borrowers to the firm. The firm finds its potential borrowers on the Internet and brings them to the LOs for counseling and gentle persuasion. These LOs may be salaried or commissioned, but commission rates are much smaller than those enjoyed by LOs of the large name lenders.
I don’t think one can infer anything about relative service quality from these facts. My observations of a few hot-shot LOs led me to the conclusion that they were great sales persons, but it is not at all clear that this translates into better counseling or other dimensions of service that affect the long-term interests of borrowers.
However, there is one other difference in the compensation arrangements of the two LO groups that I believe is relevant to service. LOs working for Internet lenders do not have any pricing discretion. The prices shown on the screen are those that apply. LOs employed by large name lenders do have pricing discretion, meaning that they can adjust the prices delivered to them, up or down as needed. That’s why they keep their price sheets to themselves.
The LO who can induce the customer to pay more than the posted price, called an “overage,” typically shares it with the lender. If the LO has to cut the price to deliver the deal, called an “underage,” the shortfall is shared with the lender. Overages are much more common than underages.
I view this as a negative. Many if not most borrowers don’t understand that their dealings with the LOs of major lenders are governed more by the rules of the bazaar than by professionalism, and their ignorance usually costs them.
Do major lenders provide better servicing? The second point raised by the LO was that Internet lenders do not service their loans, so borrowers have no idea what lender will end up servicing their loan. That is true, but it doesn’t matter unless there is some reason to believe that the servicing they end up with is inferior, and that is not the case. There is no information available to borrowers, or to me, about servicing quality. I have never heard of a case where a potential borrower wanted to borrow from a specific lender because he wanted that lender to service his loan.
Do Internet lenders fail to stand by their locks? No way. Internet lenders shift the risks involved in locking prices to the large wholesale lenders to whom they sell their loans. In many cases, these are the wholesale arms of the same large retail lenders we have been discussing. There is no difference in the quality of a rate lock obtained from the LO of a large retail lender or from an Internet lender.
However, there is a difference in borrowers’ risk exposure during the period between the time they receive the price quote on which they made their selection decision, and the time the price is locked. This can be a period of one or several days, or even longer. Changes in the market during this period create a hazard that on the lock day, the price will be higher than the price quoted earlier.
In dealing with an Internet lender, borrowers get a fair shake on market changes during this period because they can check their price on the Internet every day until it is locked. In dealing with an LO for a major lender, on the other hand, borrowers discover that the market price on the lock day is what the LO says it is. This is the source of many overages.
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.