Where a commodity or service has only one price, consumers
can easily shop around for the best price. In markets where
there are two prices, effective shopping is more difficult.
How can a product have more than one price? If the
transaction is not consummated entirely at one time but
extends into the future, there can be a price to be paid now
and a price that will be paid in the future. This is the
case with mortgages. The price paid now is lender fees
including “points,” while the price paid later is the
interest rate.
Here is an example of how dual prices complicate shopping.
The two quotes below apply to a 30-year fixed-rate mortgage.
Which of them is the better deal for the borrower?
| Mortgage Quote | Interest Rate | Lender Fees |
| A | 4% | $4,000 |
| B | 4.25% | $2,000 |
The correct answer is that it depends on the borrower:
1.
If the borrower
is income constrained,
meaning that she is grappling with a high ratio of monthly
housing expenses to income, she will prefer quote A because
it provides a lower monthly mortgage payment.
2.
If the borrower
is cash constrained,
meaning that she is grappling with a shortfall of cash
needed for down payment and other closing expenses, she will
prefer quote B because it has a smaller cash requirement.
3.
If the borrower
is neither income constrained nor cash constrained, she
should
prefer the quote that will result in the lower cost during
the period that is her best guess of how long she will have
the loan. Borrowers with short time horizons should prefer B
while those with long horizons should opt for A.
This is a challenging decision. Few borrowers have more than
a vague idea of how long they will have the mortgage,
calculating the cost accurately is beyond the capacity of
most, and lenders don’t help. To my knowledge, my web site
is the only place where a borrower can find the total cost
of a mortgage over a period specified by the borrower.
When we turn to HECM reverse mortgages, the challenge is
even greater because of the greater diversity in borrower
objectives. In the forward market, borrowers use mortgages
to buy houses and want to minimize the cost. That is it. In
the reverse market, borrowers use mortgages to meet a
variety of needs, each of which may involve a different
objective or objectives.
For example, the borrower looking to supplement her income
might select the HECM that provides the largest tenure
payment – the monthly payment that lasts until she dies or
moves out of the house permanently. The borrower looking to
acquire a reserve for contingencies might shop for the
largest initial credit line, or perhaps the line after some
period of non-use during which the line grows. In both
cases, the borrower interested in minimizing the loss of
equity by their estate might shop for the HECM that
generates the lowest loan balance after some period.
Perhaps the best head-to-head comparison of a forward and a
reverse mortgage is the case where both are used to purchase
a house. Where the forward purchaser seeks to minimize loan
costs, the reverse purchaser might have any of the following
objectives:
·
Obtain the
largest possible amount of cash at closing with a fixed-rate
HECM.
·
Obtain the
largest possible amount of cash at closing and after 12
months with an adjustable-rate HECM.
·
Incur the
smallest loan balance after N years with a fixed-rate HECM.
·
Incur the
smallest loan balance after N years with an adjustable-rate
HECM.
A senior dealing with a single reverse mortgage lender might
be offered different combinations of interest rate and
origination fee from which they can select, but they
probably will not be offered any performance measures
related to their objectives. Further, selecting from among
the offerings of one lender is not “shopping.”
The difficulties in shopping effectively for HECM reverse
mortgages provide a very strong case for multi-lender
networks. Because they cover multiple lenders, such networks
can offer shoppers more options from which to choose, and
the performance measures that shoppers need to guide their
selection.
