Best Loan Rate? Don't Bank on It

Anne Kadet

Does the airline pricing system drive you crazy? Brace yourself: Banks have started to play the same elaborate -- and convoluted -- pricing game that airlines, hotels and a host of other industries have perfected, charging customers different prices for an identical product or service.

Only what's at stake isn't a one-way ticket to Phoenix but some of the largest financial transactions most folks will ever make: mortgages, car loans and home-equity lines of credit.

The move to "price optimization," which most banks are still only testing, has been spurred by the mammoth challenges threatening the $6 trillion lending industry.

Bottom-Line Boost

Analysts say banks are looking to price optimization as a relatively quick and easy way to boost a sagging bottom line by as much as 5% to 10% in three to six months. "The return on investment is huge," says Terry Kuester, a banking consultant with Deloitte & Touche.

Most banks won't discuss or confirm the practice, but insiders say Wachovia and Washington Mutual are using the technology to set rates on home-equity loans, and Citibank is testing its own in-house version of the technology.

Bank of America, meanwhile, has experimented with mortgage loans, and big auto lenders like Ford Motor Credit and AmeriCredit are using it to help price car loans.

One lender, SunTrust, says it started considering the idea last May. According to Carl Caron, its manager of pricing and profitability, the bank sifted through years of auto and home-equity loan transactions to search for times when it might have undercharged customers willing to pay more -- or lost business with rate offers that might have been too aggressive.

The bank comes to those conclusions using software that strips out the effect of variables such as seasonality or advertising campaigns and then analyzes how often different kinds of customers accepted or rejected various rate offers. The program then pumps out a new set of rates for various customer segments.

The result? A complicated pricing system that only a computer could love. Gone are the days when everyone with a 720 credit score gets offered the same rate on a $50,000 home-equity loan.

Banks are coming up with different rates for as many as 20,000 customer segments -- defined by variables like location, loan type, transaction history and banking habits.

Prefer to apply at your local branch? A computer may decide you'll typically accept higher rates than those who apply online or by phone. Live in the Midwest or a rural outpost? The software may suggest you're likely to stomach higher rates than customers living in big coastal cities.

Banks have also discovered that loyal customers are often more likely to accept a high rate.

Critics say it's unfair to charge higher prices to some customers just because they aren't particularly rate-conscious.

But the technology will likely produce lower prices for some consumers. That's because optimization seeks to increase overall sales by getting the less price-sensitive customers to subsidize discounts for everyone else.

Lenders themselves say the strategy can be self-correcting: If they consistently make unreasonably high loan offers, they'll lose business to other banks, and the software will start suggesting lower prices. Indeed, "customers have the opportunity to not take the deal," says Tom Schwartz, vice president of profitability analysis at AmeriCredit, the $13 billion auto lender. "It's an open marketplace."

Winner or Loser?

The issue for consumers, of course, is trying to figure out which side of the price-optimization equation the software has relegated them to, which may ultimately be the banks' secret weapon. After all, says Mr. Kuester, the Deloitte & Touche consultant, "Customers might never know they could've gotten a better offer."