X. THE PERFORMANCE OF THE MORTGAGE LENDING PROCESS The enactment of RESPA required that the residential mortgage lender assume significant compliance responsibilities: (1) distribution of both the special information booklet (SIB) and the good faith estimate (GFE), (2) advanced disclosure; and (3) retention of HUD-1 forms. These responsibilities primarily involve procedural changes and do not substantially impact the basic mortgage lending process. Categorically, mortgage lenders have described these changes as costly to implement, but it is less clear that they have resulted in an overall higher cost to the lending process. Part 3 of this volume evaluates the impact that RESPA has had upon the mortgage lending and other settlementrelated processes. That discussion of impact considers changes in the lending function and evaluates mortgage lending from a perspective of pre- and postRESPA procedures. This chapter is concerned primarily with the economic performance of the market for the residential mortgage lending; that is, the extent to which the consumer is well served by being provided lending and ancillary services required for settlement at a reasonable cost. To analyze this performance, we examine the mortgage lending industry by asking the following questions: To what extent are the conditions that define pure competi- To what extent do available data on pricing of loans and Are these indications that the consumer is being provided In reading this chapter, a number of ideas that were developed in Part 1 should be kept in mind. The first reflects the major structural differences among mortgage lending institutions. These institutions primarily include mortgage bankers, commercial banks, and the traditional mortgage-oriented thrifts--mutual savings banks and savings and loan associations. Less dominant institutions include credit unions, life insurance and finance companies, and a range of other plausible sources of mortgage finance providers that fall under the category of "other". Each of these institutions, however, may be subject to substantially different federal and state regulatory requirements and may be motivated in part by substantially different incentives. Part 1 described the loan origination process as one designed to develop an investment portfolio (as is the case for most depository lenders) or a servicing portfolio (as is done by nearly all mortgage bankers). But in some situations; commercial banks perceive residential mortgage lending entirely as a customer service designed to attract or retain deposits or to attract other commercial lending business. These differences in type of lending institution and in motivation to provide mortgage financing may make it difficult to make general statements regarding the overall performance of the mortgage lending marketplace. Further clouding an assessment of performance has been a number of developments that have substantially changed the way that many financial institutions do business. In a recent article in The Journal of Retail Banking1, Mr. John G. Heimann, the Controller of the Currency, described three important ongoing trends among financial institutions that may bring about a major change in the way that they develop competitive advantages. He classifies these trends as: (1) a breakdown among geographic market barriers; (2) a disintegration of product market barriers; and (3) an erosion of interest rate controls. Each of these trends has a significant impact upon mortgage lending and upon likely changes in overall market performance. Each has allowed particular types of financial institutions to develop advantages in attracting both customers and deposits that were earlier unavailable. Each of these trends is discussed in greater detail as they apply to this consideration of economic performance. A second important idea developed in Part 1 and critical to this discussion is the twofold settlement function that is performed by the mortgage lender. In one case, the lender provides funds to finance the home purchase by a borrower; in another case, he facilitates settlement by arranging for many of the other services or providers that he deems necessary. This second function is as much a product of the lender's fiduciary responsibility in making loans as it is of his ability to efficiently make recommendations or decisions and arrange for those services. A third theme relates to the mortgage lending product. The borrower or consumer actually purchases both functions provided by the mortgage lender, i.e., the use of his funds and his efforts in taking application, evaluating, arranging for services, originating, and possibly marketing the loan to a permanent investor. Charges for both of these functions, however, are not entirely discrete. They may overlap and be expressed in any combination of mortgage rate, discount points, or other settlement-related charges accruing to the lender. This makes it difficult for the consumer to evaluate alternative costs of different mortgage lenders. A final theme relates to the actual terms of the loan repayment agreement. At settlement, the consumer is concerned with neither the actual source of the borrowed funds nor with the identity of the eventual investor. Mortgage money is a fully fungible product; as a result, it is not the money itself, but the 1John G. Heimann, "The Realities of the Marketplace", The Journal of Commercial Banking, Vol. I, No. 3., December 1979, pp. 1-4. terms accompanying the loan that are of interest to the borrower, and they may be substantially different across mortgage lenders. This chapter develops the theme that the features of the loan agreement and the interest rate, points, fees, charges, and options or decisions placed in the hands of the lender define lending practices and represent important components of the total "price" of mortgage financing. These options or decisions are a very important part of the loan agreement, and they contribute significantly to determining whether a borrower's lending terms are favorable. Certainly the right to select (or reject) other settlement service providers has an important impact upon cost, and nearly all lenders exercise this right to some extent. However, even beyond the selection of a mortgage or title insurer or of a settlement attorney or escrow agent, other terms of the loan agreement are very important and may implicitly influence costs (i.e., the interest rate, points, fees, or charges). Some of these options or decisions may include: (1) an assumability clause; (2) prepayment terms; (3) escrow requirements; and in some cases; (4) refinancing or interest rate adjustment provisions. These functions are significantly influenced by both custom and regulation, as well as by the market forces of supply (of funds), demand (for mortgage money), and levels of competition. They differ both across lender types and across geographic boundaries, and although they are a very important element of the mortgage lending product, they remain very difficult to comprehensively understand or evaluate. This analysis of performance within the mortgage lending industry follows a format similar to that of other sections in this part of Volume II. It first considers the extent to which the requirements of pure competition are present. Second, it considers other criteria for determining the extent of workable competition within the industry, along with other criteria of acceptable market performance. Finally, this section draws conclusions concerning overall mortgage lending market performance in terms of those characteristics described in Chapter VII, and it considers the impact of such industry performance upon particular consumer interests. ASSESSMENT OF EXTENT OF PURE COMPETITION Chapter VII described a purely competitive market as characterized by four specific conditions or characteristics. With regard to the mortgage lending industry, these include: (1) product homogeneity; (2) an absence of significant market influence by any single buyer or seller; (3) total information regarding financing terms and loan characteristics readily available from all mortgage lenders; and (4) an absence of barriers preventing potential mortgage lenders from entering the industry or from leaving. Each of these is considered in turn. Criteria 1: Product Homogeneity Product homogeneity is important because it allows consumers to focus more easily upon price differences among products, rather than upon a host of distinguishing product characteristics. A consideration of product homogeneity requires consideration of both: (1) the use of funds and the conditions of the repayment agreement executed between lender and borrower; and (2) the efforts or service provided by the lender in helping to bring about settlement. Chapter VII suggests that product homogeneity is a function of both product uniformity and of variation in the quality of that product. Variation in quality, however, is a less critical issue here than in other industries studied. Because from the perspective of either the borrower or the mortgage lender quality refers to the terms of an agreement or to services that are both required by and provided by the lender. As such, qualitative distinctions can be largely translated into a consideration of risk and return, and are then expressed in terms of interest rates, fees, and charges. Conditions of Repayment Terms As was mentioned earlier, mortgage money is fully fungible and entirely homogeneous; however, significant variation occurs in the definition of terms or conditions that accompany the repayment agreement. Mortgage lending, like almost all other commercial lending activities involves conditions that are defined in terms of a detailed analysis of risk and return. As a result, many terms or conditions designed to reduce a lender's risk will allow that lender to make available to a borrower a loan at a reduced interest rate. In other conventional lending arenas, lenders may require that specific debt:equity or debt service: income ratios be maintained. Within the realm of mortgage lending, the amount of down payment becomes a similar example of such a riskreduction condition. Almost all lenders will charge a higher interest rate to borrowers who provide only small down payments than to those who make larger down payments. This does not suggest an absence of produce homogeneity. In fact, a 95 percent LTVR loan is a significantly different type of loan than, for instance, a 75 percent LTVR loan, and each warrants a very different evaluation. The former suggests much greater risk for which the lender requires compensation in the form of a higher expected return. The two loans cannot be compared without acknowledging this basic distinction. However, even among loans of a similar LTVR and an identical mortgage interest rate, major product heterogeneity may exist. As was briefly highlighted in the introduction to this section, this may take the form of whether: (1) a loan is assumable (with or without an adjustment of the mortgage rate to current market levels); (2) a prepayment penalty is imposed (a factor that protects the lender's interest during periods of declining interest rates); (3) escrow requirements are made for taxes and/or insurance; (4) refinancing options are allowed; (5) private mortgage insurance is mandated; or (6) standard loan application procedures are strictly followed. This list is not an exhaustive one, but it suggests that a number of factors can influence uniformity in a loan agreement as well as a loan's desirability from the perspective of the borrower. Another controversial term or condition that can differentiate among financing terms is the commitment period within which the lender agrees to allow the borrower to go to settlement at a stated interest rate. Although not a part of the loan agreement, this can be a critical term of the financing arrangement. During periods of volatile interest rates, this term can be a very important to a borrower, particularly if he awaits completion of a newly constructed home. Delayed completion by the builder may force the borrower to forfeit a commitment and be subject to either additional charges or to a higher interest rate. Both additional costs could result in a borrower's no longer qualifying for a loan. This particular issue is discussed at greater length in a later part of this section. Other situations that may influence differential conditions in a loan repayment agreement may include: (1) a current customer or important depositor relationship; (2) a business relationship; or (3) certain personal relationships. These reasons for favorable treatment exist, are admitted to, and can represent substantial benefit to those consumers able to secure such treatment. sense. All factors influencing the terms or conditions of the financing or repayment agreement substantially undermine product homogeneity in the true economic Most unsophisticated mortgage loan applicants are unprepared to recognize or evaluate the benefit or cost of these terms; as a result, the terms are often not considered as differentiating factors. However, their existence makes much more difficult the task of comprehensively evaluating the relative merit of alternative lending terms, and substantially limits the perceived homogeneity of such terms. Lender Provided Services The price quoted for mortgage financing services is a combination of interest rate, points, fees, and charges; it reflects the services that a lender will perform as a part of the process leading up to settlement. What is contained within this package of services can vary greatly by both custom or tradition, by regulation, and by the incentives available to the lender to provide either more or fewer services. For instance, some lenders will perform settlement agent functions or require that their own attorney be present; some stated chartered S&Ls are allowed to self-insure certain high LTVR conventional loans; and some lenders may use their own staff to perform needed services that other lenders may contract for. As a result, consumers may find that the services they are purchasing as a part of the mortgage financing package may indeed be very different and may frustrate attempts to do accurate comparative shopping. Some lenders may quote a "price" for financing services and then require that particular providers of additional services be used who may represent an additional marginal cost to the settlement process. Others may require that significant costs that are nonrefundable be prepaid at time of loan application; this decreases the consumer's interest in shopping and may represent an important "sunk" cost if for some reason the closing does not take place. All of these factors contribute |