The Consumer Financial Protection Bureau recently unveiled an Internet-based tool designed to help consumers shop effectively for the lowest possible mortgage interest rate.
For this tool to work, it must help mortgage shoppers distinguish between rate differences that are justified, which borrowers would have to pay in a perfect market no matter how effectively they shop and rate differences that arise because lenders know more than borrowers and control the process, which might be overcome by effective shopping.
Let’s look at the sources of rate differences.
JUSTIFIABLE RATE DIFFERENCES
Some borrowers pay higher interest rates than others for reasons that have nothing to do with their knowledge or ability to shop. They would pay more even in a perfect market. The reasons boil down to a few key points.
Mortgage lenders set rates every morning after secondary markets have opened and they have checked the opening prices. The rates posted might last through the day, depending on what happens in secondary markets during the day.
Never trust price quotes that don’t show the date and time to which they apply. Effective shopping requires access to price quotes that are time-stamped.
UNJUSTIFIABLE RATE DIFFERENCES
For these reasons, some borrowers pay more than others on what would otherwise by an identical transaction.
One of the worst of the market imperfections, made possible by the long processing period required to generate a mortgage, is the fake price quote.
Since rate quotes do not commit a lender until they are locked, and the market is very likely to change before that happens, some lenders are tempted to “low-ball” — meaning to quote a price they have no intention of delivering — in order to be selected by the borrower.
Once the borrower gets involved in the process, such lenders have no difficulty finding explanations for a price adjustment, and the cost to the applicant of disengaging and beginning anew somewhere else becomes increasingly high.
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at mtgprofessor.com.