“Shifting control of appraisals to borrowers, and requiring lenders to purchase and pay for any insurance that protects lenders would help borrowers, but these changes would not create a competitive market in home mortgages.”

The comment above applies to a recent article of mine suggesting that Fannie Mae and Freddie Mac be retained with Government backing but with a new mission: to eliminate market dysfunction. The reader’s point is that the measures I proposed would not create a competitive mortgage market, and she is right about that. I meant my proposals as examples of what could be done, but they are not a complete package. I will remedy that shortcoming here by describing the most important barrier to effective competition in the home mortgage market, and how Fannie and Freddie could remove it.

The Major Barrier: Price Complexity and Volatility

Multiple Price Determinants: Last week I shopped for a book on-line. To do it effectively, I needed to learn from the book-sellers I contacted only the price and the shipping charge. What I intended to do with the book did not affect the price. What a pleasure!

With a mortgage, in contrast, the price is affected by everything connected to its use and features that might affect a borrower’s capacity or willingness to repay it. Here is a partial list:

• Type of property -- single-family or 2, 3 or 4-family.
• Loan purpose (purchase or refinance).
• Use of property (primary residence, second home or investment).
• Loan amount required.
• Property value.
• Escrow tax and insurance payments, or not.
• Price-lock period required.
• FICO score.  

If you leave out anything on the list, the lender will assume whatever generates the lowest price, setting the shopper up for a price increase later if that assumption turns out to be wrong. A property appraisal that differs   materially from the shopper’s estimate of value may also invalidate a lender’s price quote.  

Multiple Mortgage Types: The shopping borrower has to specify the mortgage type. Fixed-rate mortgages come with 10, 15, 20, 25 and 30-year terms. Adjustable-rate mortgages come with initial fixed-rate periods of 3, 5, 7 and 10 years. Mortgages are further sub-divided into those insured by FHA, guaranteed by VA or conventional. Each mortgage type has its own pricing.

Loan shoppers may or may not know the type of loan that best meets their needs. Typically, the major focus is on the required down payment and the initial mortgage payment, which information is readily available. Insufficient attention is paid to the costs expected over the period they expect to have the mortgage, which information is seldom if ever available from the lender.

Multi-Dimensional Pricing: The price of a mortgage consists of the interest rate, and upfront points and fees. The shopper who specifies the type of mortgage desired (say, a conventional 30-year fixed-rate), and provides all the information on price determinants, will be offered a price, or perhaps many prices from which to choose.

On the 30-year fixed-rate mortgage for $300,000 I looked at on the day this was written, a borrower dealing with the lenders who price mortgages on my site had a choice of 17 prices, ranging from 3.625% with fee of $11,878 to 5.625% with a rebate of $18,750. The borrower making a selection from this list should know which combination will result in the lowest costs over the period she is likely to have the mortgage. Few if any lenders provide this information.  

Price Data Availability: Lender web sites are not designed to facilitate price shopping. With very few exceptions, price data on mortgage sites is incomplete and cannot be used to make valid comparisons between lenders. Lenders view their web sites as advertisements, designed to entice consumers to contact them and begin a process with them alone.

Price Volatility: Mortgage lenders reset their prices every morning, and sometimes during the day. A shopper determined to compare prices of different lenders without the results being contaminated by market changes would have to do it within a single day. This won’t work, because the shopper looking to get price quotes fast, avoiding sit-down sessions with  loan officers, will be “low-balled” – given a below-market price to induce her to come back.

Removing the Barrier to Effective Shopping: Certified Mortgage Shopping Sites (CMSS)

The solution is a certified mortgage-shopping site or CMSS, which collects complete and current mortgage price data from a set of lenders who participate because of the highly qualified leads the CMSS sends them. The CMSS provides decision support, helping borrowers select the best mortgage product as well as the best price.

I see the certification of CMSSs as a critically important role for Fannie Mae and Freddy Mac in meeting a new mission to fix mortgage market dysfunction. In executing this function, the agencies would establish performance criteria, which would differ for CMSSs dealing with reverse mortgages as opposed to those dealing with standard mortgages.    

Since there is no legal barrier preventing a firm from establishing an MSS now, why the need for certification? The need arises because without certification by a reputable entity, it is extremely difficult for an MSS to differentiate itself from a host of sites that look very much the same but subsist on advertising revenue. Bear in mind that consumers shop for a mortgage once or twice in a lifetime, they don’t have multiple opportunities to figure out how the market works, so in most cases they follow the path of least resistance.

Full Disclosure Department

I have had an MSS for 5 years, it provides shoppers with all the information that borrowers should have that lenders don’t provide. I would welcome the additional competition that certification would create.