The failure of government to fix the deep-seated problems of the home loan market raises the question of whether there is a private initiative that would work better. I believe there is and will spell it out in a series of articles. This is the first.
One major problem facing mortgage borrowers is finding the best price for which they qualify. The product and the process are complex and vulnerable to all manner of deception. Some deceptions are so widespread and ingrained that they are part of mortgage banking culture.
It is equally difficult to find competitive prices on required third-party services, including title insurance and mortgage insurance. These and other third-party providers are usually selected by the lenders, who base their selection on the services they receive from the service provider, rather than on the prices paid by the borrower.
The second major problem is the lack of knowledge and understanding by borrowers faced with the need to make critical decisions, including the type of mortgage and mortgage options that best meet their needs. Efforts to address this problem by education are complicated by the wide diversity in borrower capacities.
Extensive efforts by government, including mandatory disclosures and regulation, have largely failed to help borrowers. Whatever help has been provided by mandated disclosures of information useful to borrowers has been nullified by the increased confusions arising from the torrent of mandated disclosures that are useless and misleading.
The proposed approach for dealing with these problems is a third-party network that would certify participating lenders and other service providers. The network would attract borrowers because of the information and protections they offer, which gives the network the clout to set the operating rules required for certification.
Early private networks
In 1997 and 1998, Intuit and Microsoft as well as three smaller firms moved to stake out positions in what was then seen to be a market ripe for massive growth: the origination of home mortgages on the Internet by independent third parties hosting multiple lenders. These sites allowed potential borrowers to shop prices conveniently among lenders competing for their business.
I was an enthusiastic proponent of these new sites, extolling their advantages to borrowers in published articles. The software company I started, GHR Systems Inc., developed the technology used by Intuit. It was state-of-the-art at the time.
The premise underlying the shopping sites was: "If we make it easy and convenient for borrowers to shop, they will come." They did come, attracted by the up-to-date market information the sites provided — prices on the Intuit site were updated every 10 minutes, which was mind-boggling at the time. However, very few borrowers stayed to transact. All the sites failed and were terminated except one, which converted to a single-lender site.
One obvious explanation for their failure is that the sites were premature in the sense that consumers had not yet become comfortable transacting online. This is much less the case today, which substantially improves the prospects for the next generation of sites.
In addition, the earliest sites did not assure potential borrowers that they would receive competitive pricing, even though that was the intention. Displaying price quotes of multiple lenders online is not enough to assure that transactions will be competitively priced, an important point I will discuss next week. The borrowers who viewed the first-generation sites as a convenient source of price information that could be used just as effectively shopping offline were probably right.
The next generation of sites focused on giving borrowers what many borrowers seemed to want: multiple lenders soliciting them for business. The sites ask borrowers for much less than the shopping sites, which qualified borrowers. Lead-generation sites collect just enough information to add up to a marketable lead, which is then sold to three or four loan providers who contact the borrowers.
Lead-generation sites have been commercially successful because they ask little of the borrower, the technology they require is relatively simple and cheap, and they offer a service that some borrowers find appealing. These borrowers buy into the slogan, "When banks compete, you win," not realizing that they are equally likely to lose. The leads are sold not to the lenders who will offer the best prices to the borrower but to those who will pay the most for the lead. Price lowballing — the practice of quoting a price the lender has no intention of delivering — is endemic on these sites, and the sites provide little or no decision support.
A successful private network would actually deal with borrower problems, as opposed to pretending to deal with them as lead-generation sites do.
Next week: The next generation of third-party networks.