By Jack Guttentag
Saturday, September 6, 2008

Aborrower negotiating the terms of a mortgage with a lender or mortgage broker is in what economists call 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 a transaction by threatening not to go through with 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 mind-set of petitioners seeking favors are not aware of having bargaining power and so do not have any. They have potential bargaining power, which does them no good.

Borrowers' potential bargaining power is greatest in a refinance because typically they have no time limit by which 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 once 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 money they paid in connection with the transactions.

The right of rescission is a powerful tool that strengthens refinancing borrowers' potential bargaining power. Unfortunately, most refinancing borrowers are not aware of what it does for them, and very few exercise it.

Home purchasers, during the early stages of loan shopping in which 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. 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. My files are stuffed with cases of home buyers whose mortgage terms changed when they were past the point of no return. Purchasers should get everything in writing 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 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, in which 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 it 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 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 lenders are not going to mess up their Web pricing program just to fool you.

Some lenders can provide this answer, but not many. 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 it is to end 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 brokers or lenders and prevents fee escalation by brokers. The borrower should also require the broker to guarantee the lender fee as soon as the lender has been identified.

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.

© 2008 Jack Guttentag

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