May 20, 2002
I Do Auction Sites Work For
discussed internet referral sites and individual lender sites, but I don�t see
any reference to Lending Tree, which does a lot of advertising. Where does it
Lending Tree is what I call an
"auction" site because, in theory, up to 4 lenders will bid for your
loan. I used to call them "lead generation sites", because from a
lender�s perspective, that is what they do. A "lead" is a packet of
information about a consumer in the market for a loan. Lenders pay for leads,
and auction sites are an important source of them.
In preparing this column, I looked at 9
mortgage auction sites: Cityloans.com, Getsmart.com, Interestratesonline.com,
Lendingtree.com, Loanapp.com, Loanhounds.com, Loanweb.com, Lowestmortgage.com,
and Mortgageexpo.com. While Lending Tree is ahead of the others, their
similarities are more important than their differences.
All of these sites essentially work the same
way. The prospective borrower fills out a questionnaire covering the loan
request, property, personal finances, and contact information. The sites use
this information to select the lenders to whom the information is sent. Lenders
then prepare an offer to the borrower based on the same information.
In developing their questionnaires, auction
sites are pulled in two directions. The more complete the questionnaire, the
more effectively the site can select lenders, and the more accurately the
lenders can quote prices. On the other hand, long questionnaires discourage some
borrowers -- especially those with short attention spans, or who are suspicious
that their information will be misused. Intelligent borrowers should actually
prefer sites with longer questionnaires, although a long questionnaire in itself
is no guarantee of good service.
The sites send the information provided by
applicants to "up to 4" lenders, except for Mortgagexpo.com, which
sends it to only one. Lenders are selected based on prior information provided
by the lenders regarding the types of loans, borrowers and properties that they
are prepared to consider.
For example, an applicant with poor credit
who wants to purchase a condominium would not be referred to a lender who has
told the site it only wants loans to A-quality borrowers purchasing or
refinancing single-family homes. Similarly, an applicant who doesn�t want to
document income or assets would not be sent to a lender who always requires full
In principle, the lender selection function
performed by auction sites should be particularly valuable to borrowers with one
or more challenging features, such as poor credit, incomplete documentation, or
little cash. Such borrowers can avoid wasting time soliciting lenders who won�t
deal with them.
How well the sites perform this function,
however, is difficult to determine. My impression is that they try to acquire as
many reputable lenders as possible, assuming that if they have enough lenders,
the coverage of widely diverse borrower needs will take care of itself. I�m
not sure that it does.
The only concrete information I can report is
my own experience as an applicant pretending to refinance. Unfortunately for the
test, my credit is excellent, I live in a single-family home, and I can document
everything. But my niche is a bit unusual in that I am both retired and
self-employed, a combination that gives some computerized systems difficulty.
None of the 8 sites I tried gave me 4
lenders. Two offered 3, and the remainder offered 1 or 2. (The ninth site
discovered who I was and aborted my application). I felt too guilty about
wasting the time of loan officers to repeat the exercise using fictitious
information about myself.
The lender screening process employed by the
auction sites also provides some protection against falling into the hands of
rogues � lenders or mortgage brokers out to extract as much revenue as
possible from every customer. The sites have every reason to bounce a lender who
attracts multiple complaints from borrowers. Only Lending Tree, however, has
developed a rating system for its lenders based on reports from borrowers.
In sum, auction sites may be useful in
screening out rogues, and in allowing borrowers with poor credit,
less-than-complete documentation or little cash to find lenders that deal in
those market niches. Such borrowers will probably do better at auction sites
than by throwing darts against the yellow pages, or by visiting single-lender
sites. (With few exceptions, single-lender sites don�t quote prices that apply
to them). Strong borrowers who can find their desired loans priced on
single-lender sites, will probably do better shopping those.
II Do Auction
Sites Promote Competition ?
In Column I, I indicated that internet
auction sites may be a good way for borrowers with poor credit or other
weaknesses to find one or more reputable lenders who are willing to work with
them. This column considers whether auction sites promote lender competition in
ways that benefit borrowers.
The answer depends first on whether the
initial price quotes provided through the sites are complete enough to allow
borrowers to make intelligent choices. Second, it depends on whether borrowers
are protected against "sharp practices" by lenders during the period
between initial price quotes and the time when the price is "locked".
Initial Price Quotes: Fixed-rate mortgages (FRMs)
have 3 price components: interest rate, points (upfront charges expressed as a
percent of the loan), and lender fees (upfront charges expressed in dollars).
Borrowers can�t shop effectively unless they have all three.
Lending Tree is unique among auction sites in
displaying the three price components from all responding lenders on its site.
The lenders selected by the other sites provide prices over the telephone,
email, or fax. In many cases, the prices don�t include lender fees, and in all
cases (except Lending Tree) borrowers must record and organize this information
Adjustable rate mortgages (ARMs) have
additional price components: the interest rate index used by the ARM, the margin
that is added to the index in resetting the rate on an adjustment date, any caps
on the size of rate changes, and the maximum rate. None of the auction sites
provide this information, which has to be obtained directly from loan officers.
Borrowers who might hold an ARM past the first rate adjustment date need this
information, but most don�t realize they should ask for it.
Sharp Practices: A mortgage lender quoting
prices on an auction site is not bound by those prices. Mortgage prices are
reset every morning, and sometimes during the day. The price quotes that
borrowers use to select a lender, even if complete, apply only to the day they
are posted. The next day the quotes are obsolete. For price updates, borrowers
are dependent on the loan officers who contact them.
The only prices that really matter are those
quoted at the time the borrower locks the loan with the lender. The borrower who
selects one lender to work with based on the initial price quote is vulnerable
to gamesmanship. An initial price that is favorable to the borrower, because
there was competition at that point, is converted to a locked price that is more
favorable to the lender.
This is done by overstating the rise in
market prices that occurs between the time of the initial quote and the lock
date -- or understating the decline. For example, the initial quote was 7% at
zero points, the market on the lock day is 6.75%, but the borrower is locked at
Sharp lenders can also take advantage of a
borrower who decides, either before or after they lock the loan, that they want
a different type of loan. For example, they lock a 30-year FRM at 7% but decide
to switch to a 15-year FRM on a day when the 15-year quote is 6.625%. Since the
borrower is already committed, the lender locks the 15-year at 6.75%.
Sharp lenders also may pad their loan fees,
particularly if they hadn�t included fees any in the initial price quote to
the borrower. Indeed, fee padding can extend right through to closing, since
locks only cover rates and points.
These practices pervade the home loan market.
The question is whether auction sites provide any protection against them? They
claim to, through their due diligence in selecting and monitoring lenders.
Lending Tree provides a scorecard of lender performance based on reports from
borrowers, and also assigns a "personal custom care advocate" to each
There was no way for me to assess the
effectiveness of these protections. It is plausible that they may prevent
flagrant or obvious abuses, but certainly not the more subtle ones. The borrower
who pays 6.75% when the competitive rate is 6.625% usually doesn�t know it,
and neither does the site.
In sum, except for FRMs on Lending Tree,
auction sites don�t offer the complete pricing required for effective
competition. How well they do in protecting borrowers against lender abuses is
unclear, but I�m skeptical. Clearly, they could do a lot better on both
scores, and I�ll indicate how in Column III.
III How Auction Sites Could Do
In two prior columns, I indicated that
internet auction sites are a better way to find a reputable lender than blind
selection, but they don�t live up to their promise of providing competitive
pricing. In this column, I will sketch the features of an auction site that
would provide competitive pricing, and also facilitate better loan decisions.
Call it the "Generation Two" (GT) site.
Complete Prices on Line: The GT site
would provide complete pricing on-line for the ("up to 4") lenders
selected by the site for a particular borrower. If borrowers are going to select
the best deal, they must have complete price information.
On fixed-rate mortgages (FRMs), required
information includes the interest rate, points (an upfront charge expressed as a
percent of the loan), and lender fees (upfront charges expressed in dollars).
On adjustable rate mortgages (ARMs), the SG
site would disclose these as well as other price components. But more
importantly, the site would pull all these factors together in projections of
future performance. On any ARM offered by participating lenders, borrowers would
be shown what might happen to the interest rate and mortgage payment at future
rate adjustment dates under different assumed scenarios. These would include a
scenario where market interest rates are stable, and one where they explode �
a "worst case".
"Try-on" Capacity: In
selecting their lender, borrowers would not be limited to the one or a few loan
programs received from each lender. Through the SG site, they would have access
to all the programs of each lender, so they can "try them on." The
selection tools noted below will help them make decisions.
Guaranteed Dollar Fees: The site would
require lenders to guarantee their dollar fees at the outset. This imposes
minimum hardship on lenders while removing a pervasive source of potential
Selection Tools: In shopping for a
mortgage borrowers have 4 decisions to make: type of loan � whether FRM or
ARM, and if the latter, which of many variants; loan term; down payment; and
rate/point combination � high points and low interest rate, or the reverse.
The SG site will have on-site selection tools
that will help borrowers make these decisions at the time they select the
lender. One of these tools, designed to help borrowers select among ARMs or
between an ARM and a FRM, was described above.
Existing auction sites help very little in
making these decisions. The unstated assumption is that these decisions have
been made at the time the borrower fills out the questionnaire. But often that
is not the case, and even when it is, the decision may be poorly grounded.
Some of the existing sites have calculators
that are supposed to help with these decisions, but the prices must be obtained
somewhere else, which greatly reduces their value. The tools on the SG site will
use live market data from the participating lenders.
Price Change Protection: A borrower
selects a lender from an auction site based on that lender�s initial price
quote, but the lender is not bound by that quote. Lenders may practice
gamesmanship during the period between the initial quote and the time when the
price is locked. If market prices decline in that period, for example, the
lender might neglect to reduce the lock price.
On existing sites, the only protection
against gamesmanship of this type is monitoring by the site, but borrowers would
be far better off protecting themselves if they had the tools with which to do
it. The GT auction site will provide the tools.
First, the GT site will have a rule, to which
lenders must subscribe, that the lock price must always be the same as the price
the lender is offering to new customers on the same day. Second, the site will
give borrowers continual on-line access to the prices posted by their lender
until the loan closes. This will allow borrowers to do their own monitoring to
assure that the lender follows the rule.
Loan Change Protection: The same rule
and monitoring procedure will protect borrowers against being short-changed in
the event they elect to change the loan type, term, rate/point combination or
down payment. If they elect to switch from a 30-year to a 15-year FRM, for
example, they have a right to the price on 15-year FRMs being quoted to new
borrowers on the same day.
The GT auction site won�t appear anytime
soon. In the column that follows, I�ll provide a checklist for making the best
use of existing sites.
on How to Use Auction Sites
Auction sites could provide the following
advice to borrowers:
1. Before using this site, you should have
decided whether you want a fixed or adjustable rate mortgage, as well as your
preferred loan term, down payment, and points. If you are uncertain about any of
these, do some homework. You might peruse the relevant sections of the Mortgage
Professor�s web site.
2. Fill out the questionnaire as accurately
and completely as you can. We use the information you provide, together with
information we have on the preferences of our lenders, to match you with the
lenders most likely to be interested in your loan. Our matching can be no better
than the information we receive from you.
3. This site does not provide mortgage price
information. That comes from the lenders who contact you. The amount of price
information they give you may depend on what you ask for. Remember that on
fixed-rate mortgages you need the interest rate, points and dollar fees. While
some lenders are not in the habit of providing their dollar fees in initial
price quotes, you can insist upon it.
4. If you are interested in an adjustable
rate mortgage (ARM), you need to know more than the rate, points and loan fees.
Also ask the lenders for the interest rate index, margin, all rate adjustment
caps, and maximum rate. Once you have that information, you can see use the
Mortgage Professor�s calculator "Monthly Payments on Adjustable Rate
Mortgages" to see how the payment might change.
5. Receiving price quotes over the telephone
is looking for trouble. Ask lenders to email or fax their prices to you.
6. The interest rate and points quoted to you
by a lender apply only to the day you receive them. The lender is not bound to
them the following day, since the market may have changed. For the same reason,
it is not safe to compare a price received on Monday from one lender with a
price received on Tuesday from another.
7. The prices that really matter are those
quoted to you on the day you "lock" the loan with the lender. The lock
means that the lender is committed to the prices, and so are you!
8. Since locking imposes costs on lenders,
they want some evidence of your commitment to the deal before they will lock.
Their requirements vary widely, however, ranging from very little, to a signed
application, to a signed application plus a non-refundable payment. You are
entitled to know at the outset exactly what each lender�s requirements are,
and how long it should take if you do everything expected of you. Ask!!!
9. Since you selected the lender based on the
initial price quote but it is the locked price that you are going to pay, you
have a right to know how the lender will set the price on the day you lock. You
need not accept a statement that the new price "will be at the
market". The answer you are looking for is that the lock price will be the
same as the price the lender is quoting to new customers on the identical loan
on the same day. Ask if the lender has a web site that contains up-to-date
prices that you can use to monitor your price day by day. If it does not, ask
the loan officer how he intends to demonstrate that you have received the
10. Unlike rates and points, loan fees are
not market driven. Unless you change one or more of the loan characteristics,
there is seldom a good reason for these fees to change between the time you
receive the initial price quote and the time you close.
Some lenders will guarantee these fees in
writing if you ask. Bear in mind that these are lender fees only, a lender can�t
guarantee the fees of third parties. However, lenders may be willing to include
appraisal fees and credit charges in a guarantee because they order them and
know how much they cost.
Copyright Jack Guttentag 2002