A consumer negotiating the terms of a mortgage with a lender or mortgage broker (henceforth "loan provider") is in what economists term a "bilateral bargaining process." Only two parties are involved, and the terms arrived at depend in part on their respective bargaining power.
Bargaining power is the power to influence the terms of the transaction by threatening not to do it. The bargaining power of borrowers is inseparable from the knowledge that they have it and their willingness to use it. Borrowers entering transactions with the mindset of petitioners seeking favors are not aware of having bargaining power, and as a result do not have any. They have potential bargaining power, which does them no good.
The potential bargaining power of borrowers is greatest on a refinance, because typically they have no time limit on when the money is needed. This usually means that they can break off negotiations with one loan provider and begin with another without being seriously inconvenienced.
In practice, many refinancing borrowers are solicited by loan providers and are unaware of their options. Abuses in connection with refinance solicitations were so common that Congress decided to protect refinancing borrowers by allowing them, within three days of closing, to rescind a deal with any lender other than the one holding their current mortgage. Borrowers who rescind have the right to recover all monies they have paid out in connection with the transactions.
The right of rescission is an extremely powerful tool that strengthens the potential bargaining power of refinancing borrowers. Unfortunately, most refinancing borrowers are not aware of what it does for them, and very few exercise it.
Home purchasers, at the early stages of loan shopping where they select their loan provider, have much the same bargaining power as those involved in a refinance. However, as the period to closing shortens, purchasers lose their bargaining power. They need the loan proceeds on a specific day — the day on which the contract of sale says the transaction will be consummated — and if there no longer is sufficient time to start the process again with a new loan provider, they are stuck.
Once past this point, the loan provider is in the driver’s seat. Both parties know that failure to close means loss of the house along with any deposit the purchaser has pledged. My file is stuffed with cases of home purchasers who had the mortgage terms changed on them when they were past the point of no return. Purchasers should finalize their negotiations, which means getting them down on paper, well before they reach this point.
What exactly should mortgage borrowers use their bargaining power to bargain for? In dealing with a lender, it can be anything the borrower is concerned with, but most borrowers would do well to focus on shutting down the two principal games that lenders play to improve their profit margins. One is to escalate their fixed-dollar fees, which existing rules allow them to do with impunity right up to closing. Borrowers can eliminate this game by requiring the lender to guarantee total fixed-dollar fees in writing. The total is all that matters — no fee-by-fee breakdown is necessary.
The second game is price lowballing, where lenders quote a rate and points below what they are prepared to deliver. (Points include all fees expressed as a percent of the loan amount). Because the market changes frequently, lenders cannot be held to a price until the borrower is ready to lock, which usually requires approval of the borrower’s application. When the time comes to lock, the lender raises the price to a more profitable level, explaining that that is the current market price.
To beat this game, the borrower needs to know exactly how his price will be set at the time it is locked. "We will price you at the market on that day" is a common — but not an adequate — answer because it doesn’t tell you anything you can check for yourself. "You can check the price we lock for you on our Web site" is a good answer, as they are not going to mess up their Web pricing program just to fool you.
The seven lenders I have certified as Upfront Mortgage Lenders can provide this answer, which is one of the reasons I certify them, but not many others can. If they shrug their shoulders and ask why you don’t trust them, it may be time to go to a mortgage broker.
In general, it is easier for borrowers to use their bargaining power to eliminate mortgage broker games than lender games. You need only to establish the broker’s total fee, including any fee paid to the broker by the lender, in writing. This protects the borrower against lowballing by broker or lender, and prevents fee escalation by the broker. The borrower should also require the broker to guarantee the lender fee as soon as the lender has been identified.
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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