Jack M. Guttentag The Mortgage Professor

Is every bill of rights a benefit? 

Five years ago, I wrote an article on Internet mortgage referral sites, six of which I examined with some care. In 2007, loan.com joined the group, claiming a unique distinction: All the loan providers on their site have to abide by a borrower's 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 to a referral site model on which it doesn't work. It is the same model used by the firms I examined in 2002, and 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 current. (Prices reported in newspapers are often obsolete once published.) Referral sites connect to the Web sites of the loan providers listed, and may also show their telephone numbers, which is convenient.

Hazards of Selecting Low-Price Loan Providers

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.

First, the prices shown apply only to borrowers who meet the highest underwriting standards -- for "creampuff loans." In the case of loan.com, the posted prices don‘t apply if your credit is less than good, if you are putting less than 20 percent down, 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 constitute 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 or small-down payment loan. The correlation is close to zero.

Second, you can't shop adjustable rate mortgages (ARMs) effectively on the site, 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 is over. These include the rate index, margin, rate-adjustment caps, and maximum rate.

The Temptation to Low-Ball

Third, and most important, borrowers can't fully rely on the prices shown on the screen because referral sites provide an enormous temptation to low-ball - that is, to price below the price the loan provider actually expects to deliver. A low price is the only way a loan provider has of grabbing the borrower's attention.

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

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

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

Pattern of Widespread Violations

Dozens of bounces a month indicate 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 them permanently.

The borrower bill of rights in 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 had to adopt the same tactic as bankrate.com to deal with it. Loan.com has mystery shoppers to check for compliance, and they suspend 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 this problem.