Why Your Mortgage May Cost More Than You Expected

August 8, 2011, Revised January 10, 2012

One of the unusual features of the US mortgage market is that borrowers are obliged to select a lender before they know the price. They have a price quote from the lender they select, and the quote may be instrumental in their selection decision, but the price is preliminary. It is not final until it is locked by the lender.

 Lock Prices May Differ From Quoted Prices

Before the financial crisis, it was common to lock on the spot, which meant locking the quoted price. Today, that is the exception, reflecting tighter underwriting requirements and the increased risk to lenders of closing a loan that does not conform exactly to the rules. Locks are usually delayed for some days, sometimes for weeks.

Delays in locking mean that the lock price can differ from the price quote on which the borrower made a selection decision. The lock price can be higher or lower, but more often than not it is higher. These articles will explain why.

 Changes in Market Conditions

One reason the lock price can differ from the quoted price is that market conditions change. Mortgage prices are reset every morning, and sometimes during the day. Until the loan is locked, the price will change with the passage of time.

Since the market price is as likely to be lower than the quoted price as to be higher, borrowers should benefit from market price changes as often as they are hurt. It doesn’t quite work out that way, however, because when prices decline, the lender may not pass it on -- they may lock at the previously quoted price. They can usually get away with this because the borrower is getting what was expected.

The lender may feel justified in not passing through price reductions because when the price rises by a small amount, the lender may absorb it by taking a smaller markup. The amount involved in not worth a hassle with the borrower. If the price rise is too large to absorb, however, the lender will require the borrower to pay it. On balance, therefore, borrowers are disadvantaged by market price changes prior to a lock.

There is one exception to this statement. Borrowers who use the Certified Lender Network get a fair shake because they always receive the benefit of a reduction in market price. The reason is that their price comes from the lender's price system, not from a loan officer. The  lock price is the same as the price that would be quoted to the borrower's twin sibling who was shopping at the same time. See Finding a Mortgage on the Professor's Certified Lender Network.

 Changes in Credit Score

The quoted price can also change because the lender has not been able to verify one or more pieces of information on which the price depends, and has corrected them. These corrections may be reported to the borrower informally by the loan officer. They will also be contained in the documents the borrower receives within 3 days of receipt of the loan application. The documents include a corrected loan application. a credit score disclosure, and a Good Faith Estimate (GFE).

The critical items that may change are the credit score, property value, and loan amount. The credit score used to price a mortgage is the one received by the lender, not the one obtained by the borrower. There are a number of scoring models from which lenders make a choice. Each of the three major credit repositories has its own model, with multiple versions of each. Usually lenders pull scores from three models and use the middle one, or they pull two and take the lower one.

The different models generate different scores but usually the differences are not large. If one model score is 750, another won’t be 650, but it might be 740. Even a small difference, however, might be enough to affect the price.

The impact of credit score on price is based on score ranges that are 20 points wide on the most widely used FICO score models. The ranges are 620 to 639, 640 to 659, 660 to 679, and so on. This means that if the score reported by a borrower is near a break point, it takes only a small downward correction to drop him into a lower score bracket that could raise the price. An example would be a shift from 620 to 619. By the same token, if the score obtained by the borrower was 639, an increase to 640 would shift her into a higher score bracket that could lower the price.  

In principal, credit score corrections by the lender (like market price changes) should lower the mortgage price as often as they raise the price. I am skeptical that that is the case, however, partly because borrowers are more likely to over-estimate their score than to under-estimate it. Further, I am confident that some lenders do not pass on price reductions from an upward revision of the credit score when they don’t have to. Few borrowers are alert enough to catch it, especially if the lock price is the same as the price they had been quoted.

Again, however, the Certified Lender Network is an exception. If the lender changes the credit score, borrowers have the capacity to check the revised price by accessing the lender's prices.

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