The prices posted every day by retail lenders for their loan officers and by wholesale lenders for their mortgage brokers are very competitive. No retail lender can afford to disadvantage its loan officers by giving them prices noticeably higher than those of other retail lenders. Wholesale lenders are equally if not more careful because they know that mortgage brokers routinely compare wholesale prices, and can easily move their business from one lender to another.

These "inside prices" are disseminated every morning, usually over the Internet. They are strictly for the use of loan officers and mortgage brokers dealing directly with borrowers. I will use the term "loan officer," or LO, to mean both.

The noncompetitive part of the process is the interplay between the LO and the borrower. The higher the price LOs can induce their customers to pay, the more they make on the deal. This part of the mortgage market is like a camel bazaar. The camel bazaar works better, however, because the information disadvantage of the buyer is smaller.

Camel buyers are generally experts about camels, and while they do not know as much about the particular camel being sold as the seller, they are free to examine the camel. Mortgage borrowers usually know very little about mortgages in general, and they can't access the price sheets that would disclose the inside pricing of their particular loan.

The upshot is that the LO knows the competitive price and the borrower doesn't. A "straight-arrow" LO - there are a few -- will quote the price on the price sheet. If a mortgage broker, the LO will add a reasonable target markup (perhaps 1 to 1.5 points) to the wholesale price and quote that price.

The price is not confirmed until locked in writing by the lender, and the market can change between the quote day and the lock day. When the lock day arrives, however, the straight arrow will use the same procedure to find the lock price that was used to find the earlier quote price. A retail price will come right off the price sheet and a wholesale price will carry the exact same markup.

If the LO is out to make as much on the deal as he can get away with, which is the pervasive practice, the price on the price sheet is only a starting point. If you are pegged as a dependent-type personality who knows very little about mortgages, has no inclination to shop and a strong inclination to trust, the quoted price will be high.

On the other hand, if the LO pegs you as a committed shopper, he may change his tactic to the exact opposite, quoting a price well below any legitimate price you might be quoted elsewhere. Of course, the LO has no intention of delivering this price, the sole purpose of the low-ball quote is to hook you - start the lending process and turn you away from other loan providers.

The LO will warn you that the market is volatile and you will get the "market price" on the day you lock. When that day arrives, however, you discover that the market price is what the LO says it is!

If you are a house purchaser and there isn't enough time before the closing to find a new LO, ouch, he has you. If you are refinancing to raise cash and eager to get it, your position may be almost as weak. If you are refinancing for other reasons, the LP will price based on an assessment of the likelihood that you will walk away or rescind the deal after closing.

In sum, most LOs overcharge mortgage borrowers because they can, and they can because LOs have critical pricing information borrowers do not have.

Next week: Avoiding The Bazaar

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

Copyright 2005 Jack Guttentag