Lack of information has always been a major problem for mortgage borrowers. They may not understand:
- the mortgage and how it works, especially if it’s an ARM, interest-only, or both;
- the players they deal with, whether loan officer or broker, and the significance of the difference;
- the pricing, which in addition to the interest rate includes lender fees of different types, and third-party fees for required services, such as title insurance;
- the process, from inquiring, to applying, to locking, to processing, to closing;
- the disclosures mandated by government, which can help only the few who understand them;
- the loan contract, full of legalese, which borrowers usually don’t get to see until the closing.
The articles I have written about these issues over the last 12 years populate my website, www.mtgprofessor.com. There is another information problem, however, that is not on my list and that I have never written about until now. It wasn’t too important before the financial crisis, but it is very important now.
The problem is that borrowers have great difficulty determining their status in the marketplace prior to entering the market. Can they command the lowest possible price for the loan they need? Some price above the lowest? How much above? Or are they shut out of the market altogether?
It is very difficult for borrowers to determine their status because the underwriting rules used by lenders to control default risk have become more stringent, and mortgage prices are affected much more than they were by transaction features related to risk — especially credit score and downpayment.
Here are some hypothetical examples of possible borrower befuddlement:
Smith needs a $400,000 loan and can put 20 percent down, but because her credit score is a mediocre 655, she pays a rate of 5.375 percent on a conforming standard loan. If Smith could increase her score to 660, she would pay 5.25 percent. With a score of 680, she would pay 5.125 percent; with 700 she would pay 5 percent; and with 720 she would pay 4.875 percent.
Riley needs a $200,000 loan and has a 720 credit score but can put down only 3.5 percent, which is possible only with an FHA-insured loan. The rate is 4.875 percent. If Riley could increase the downpayment from 3.5 percent to 5 percent, he could qualify for a conforming standard loan at the same interest rate but without the 2.25 percent upfront mortgage insurance premium required on the FHA.
Smith and Riley, if they were aware of all their options, might or might not elect to delay getting a loan in order to improve their status. But the decision should be theirs based on complete information.
If they enter the market without the information, the loan officer or mortgage broker with whom they deal may or may not volunteer it. They are under no legal obligation to do so, and their financial self-interest lies in closing loans, not in providing information that may cause potential clients to leave. I know some who will do it because it is the right thing to do, but most of them won’t.
Mortgage Grade, an innovation introduced by Home-Account.com, evaluates the borrower’s status in the marketplace. The highest grade means the borrower can command the best price available in the market for the mortgage requested, and it scales down to the lowest grade where the borrower cannot qualify for the loan.
The grade is based on the borrower’s credit score, downpayment or equity in the property, ratio of housing expenses plus other debt service to income, and cash reserves above the amount required to close the transaction. Home-Account offers those receiving a grade less than the best concrete suggestions on how to raise it.
Home-Account operates a network of lenders who compete to make loans to the potential borrowers it has graded. The hypothetical examples I used were based on actual prices and underwriting requirements posted by these lenders on April 29.
Home-Account provides a mortgage grade, along with suggestions on how to improve it, prior to any contact between the user and the lenders on the network. It obtains the required information, including credit report and an estimate of the user’s property value, at its own expense.
Of course, Home-Account wants the potential borrowers who come to its site ultimately to obtain a loan from the lender on the site offering the best price at that time, which is when Home-Account gets paid. It is betting that those who decide to improve their grade before proceeding with a loan will return as borrowers when the time comes.
Potential borrowers can be graded by accessing www.mortgagegrade.com. Other websites that want to offer this functionality can get the details there as well. I will be putting it on my site as part of a special version of the Home-Account system that is being developed to my specifications, to be available later this year. Readers should know that I own shares in and am a director of Home-Account.
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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