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Shopping for a Loan Online? Beware of Lowball Offers.

By Jack Guttentag
Saturday, January 19, 2008

I wrote an article five years ago on Internet mortgage-referral sites, six of which I examined with some care. In the intervening years, more have popped up. One relatively new site, Loan.com, claims a unique distinction: All the loan providers on the site have to abide by a borrower bill of rights.

The question is whether this provides any substantive benefit to borrowers or is just another species of hype.

I think the site sponsors get an "A" for effort, the same type of "A" I received as an 8-year-old when I tried to vault a bar and landed on my head. The problem is that they applied the idea of certifying loan providers, an idea I have supported, to a referral-site model on which it doesn't work.

That referral model is similar to that of the firms I examined previously, which are still operating: BankRate.com, BestRate.com, CompareInterestRates.com, Domania.com, Interest.com and LoanPage.com.

Referral sites charge loan providers who post their mortgage prices on the sites. They are a better information source than newspapers because their coverage is generally wider and the prices are usually up to the minute. (Prices reported in newspapers are obsolete when published.) Referral sites connect to the Web sites of the loan providers listed and may also show their telephone numbers, which is convenient.

However, selecting loan providers who show the lowest prices on a referral site is hazardous, for three reasons. I will illustrate these reasons with Loan.com, though they apply to the other referral sites, as well.

  • The prices shown apply only to borrowers and loans that meet the highest underwriting standards -- "creampuffs." In the case of Loan.com, the posted prices don't apply if your credit is less than good, if you are putting down less than 20 percent, if you cannot fully document your income and assets, if you are refinancing to take out cash, if the property is anything but a single-family house, or if the property is not your permanent residence. These exclusions cover a majority of borrowers. It is foolish to expect that the lender with the best price on a creampuff will also have the best price on, say, a low-documentation loan or a loan with a small down-payment. The correlation is close to zero.

  • You can't shop adjustable-rate mortgages effectively, even if your loan is a creampuff, because information is not provided on ARM features that affect the interest rate after the initial rate period. These include the rate index, margin, rate-adjustment cap and maximum rate.

  • Most important, borrowers can't fully rely on the prices shown on the screen because referral sites provide an enormous temptation to low ball, or give a price below the price the loan provider actually expects to deliver. A low price is the only method a loan provider has to grab the borrower's attention.

    Loan providers can't be held to the prices they quote because they are committed only when they lock, at which point the market may have changed. The market is volatile, with prices resetting daily and sometimes within the day.

    Further, the final price is contingent on the borrower being approved. That process provides ample opportunity for price adjustments, many of them legitimate, such as when the borrower does not meet all the underwriting requirements assumed in the displayed prices. An illegitimate increment that pulls the low-ball quote from the borrower's grasp can easily be concealed in a legitimate price adjustment.

    The largest of the referral sites, BankRate.com, has been sued by a loan provider claiming that other providers were low-balling. In its defense, BankRate.com claimed that it polices the behavior of its loan providers through "mystery shopping" and that if it finds that a loan provider is not honoring the prices posted on BankRate, it will temporarily suspend it from advertising there. BankRate's chief executive was quoted in the Wall Street Journal as saying, "It's a pretty onerous policy and we bounce dozens of people a month."

    Dozens of bounces a month indicates a pattern of widespread violations. It also indicates that the punishment of being unable to list for a few days is not much of a deterrent. It is not in the financial interest of the site to bounce the lenders permanently.

    The borrower bill of rights on Loan.com includes a "rate quote that won't change," i.e., no low-balling. But low-balling happens, despite the pledge, and Loan.com has adopted the same tactic as BankRate.com to deal with it. Loan.com has mystery shoppers to check for compliance, and it suspends violators -- but not for very long.

    Given the existing referral site structure, low-balling is an insoluble problem. I predict that in 2008 a new type of referral site will arise that does not have that problem.

    Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site, http://www.mtgprofessor.com.

    Copyright 2008, Jack Guttentag

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