The term “bait and switch” is a favorite amongst consumers when dealing with mortgages. It’s a refrain heard every day in our industry. Somehow uttering this term gives consumers personal strength and a sense of confidence. “I’m not going to fall for any ‘bait and switch'” is a chant designed to ward off the specter of the deed made famous by unsavory mortgage brokers and loan officers. I can’t blame consumers for doing it either, I do the same thing to car salesmen by saying “I’m not going to want the dealer warranty” before I even take two steps on the lot. Even if it isn’t the perfect elixir, it feels empowering, which is something. What most mortgage borrowers don’t realize however is that their old foe the ‘bait and switch’ has morphed, like any terrible virus, in to a new strain of deceit which is being exacerbated by the current market.
First, let’s recap what the “old,” unsophisticated bait and switch schemes consist of. The “bait and switch” consists of promising loan terms that are good enough to get the borrower committed (“off the street” in industry parlance) and then, after they put their time and energy in to the process, delivering significantly different terms on their loan documents at the signing table. The hope being that the customer is too exasperated or desperate to put up much of a fight, and they accept the new terms. This can take the form of any of the following (and more based on loan officers’ personal proclivities):
- A low rate that is suddenly higher
- Loan type is suddenly different (i.e. from a fixed rate to an ARM)
- Loan fees are suddenly significantly higher, much higher
- Prepayment penalties suddenly arise
- Significantly less cash returned to the borrower than anticipated
Luckily consumers can be vocal, and were in complaining about these unsavory practices; hence the “bait and switch” buzzword arose to describe this industry practice. However, while the “old” way of bait and switch was outed; a new, more subtle form has quietly arisen. The worst part? It is completely legitimate under existing laws; and very hard to prove.
The new “bait and switch” is what I call the “value bait and switch” (bait and switch 2.0 was too easy). A little background on its development. With the advent of more vigilant consumers no longer standing for old bait and switch tactics, loan officers realized that the unsophisticated ways of attracting clients were out moded. They resulted in too many borrowers who didn’t sign, or signed and cancelled, and a bevy of complaints to their employers and regulators. But loan officers still needed to stand out. Along came the internet and its offer of banks competing for your business. Now with a zero sum, low cost game, loan officers needed to find a way to attract customers while still making a living. They needed a way to out compete the other guys while still making a profit. The way is the house value.
Here’s how it works.
- What all loan officers know, but smart loan officers leverage is that loan to value (LTV) is a key factor in determining a borrower’s interest rate. The lower the LTV, the better the rate.
- When a loan officer looks on a rate sheet (which they use to quote your rate) they see the different interest rates listed by credit grade, document type and loan to value. The rates differ as those elements (and others) change.
- During your interview the loan officer will ask you what your home is worth. You will give them an estimate. The smart loan officer is going to look up comparable sales — homes that are like yours in your neighborhood and their sales price — to see if what you think your home is worth matches the general market conditions in your area. The two of you will settle on a number.
- Here is where the new bait and switch comes in. If loan officer “A” thinks your home is worth $280,000 and you are interested in a loan of $250,000 (a LTV of 90%) he will quote you a rate based on 90% LTV. If loan officer “B” thinks your home is worth $312,000 that same loan now has a LTV of 80%.
- The difference in interest rate between the 90% LTV loan and 80% LTV loan is going to be significant.
- Loan officer “B” employs the new bait and switch to quote you the 80% rate instead of the 90% – even if he knows it is a stretch for your home to be worth $312,000.
Of course you like the fact that someone thinks your home is worth more, and has the data to back it up! Of course you like the lower rate. Of course you are going with loan officer “B” all day long! Congratulations! You have now been baited.
Happy with your interest rate and enjoying the newly-acquired prestige that comes along with a higher home value you begin on the path of the refinance transaction. Everything looks good, the loan program is as expected, the rate, fees and everything else has been on the level. You are happy that you have an honest loan officer. You have the appraisal ordered on your house and pay the $350 out of your own pocket to move the loan forward. All smooth sailing here. Then the phone call comes.
It’s loan officer “B” with the news, “I’m sorry ma’am, the appraiser believes your house is only worth $280,000. There is nothing that I can do about it — they are independent third parties and it’s illegal to try to influence them.” Crushed, you ask what your options now are. They then go on to offer you the 90% LTV loan rate and terms. You are resigned to the fate of the 90% loan. You don’t even remember loan officer “A” or whether what they were offering 2 weeks ago was any better or worse than the new offer. Plus, you’re out $350, two weeks of time, and your loan officer hasn’t done anything wrong on his end. So you go through with the loan at 90%, and feel somewhat dissatisfied, but don’t necessarily blame your loan officer for the development.
Guess what? Your loan officer did something very wrong. By being overly aggressive on the estimate of your home value he was able to out price the competition for just long enough to bait you in to the idea of the 80% LTV loan and working with him. Once you were financially committed with the appraisal fee he knew there was little chance of you leaving — plus he had the perfect cover of an independent third party to blame for the change. It wasn’t him, he protests! Of course it was him! As a professional he should know to be more conservative with your home value estimate up front. He should take in to account existing market conditions and the potential of price stabilization/declines that currently exist. But he doesn’t. Why? Because he’s using the new “bait and switch.” He is using your ego against you by inflating your property value. As a consumer though its an easy trap to fall in to.
There are a few things you can do to protect from the “value bait and switch”.
- Get familiar with what your home is actually worth. When you talk with loan officers ask them to fax you copies of the comparable sales reports that they are using to make their estimates. You’ll be able to see the home data that they are looking at and make a determination of what your home is actually worth.
- Ask each loan officer you talk to what they think your home is worth and take an average. If one loan officer seems way off the map, remember the old adage: “It it’s too good to be true, it probably is.”
- Do some research online and see what other homes in your area are currently listed at on sites such as Trulia.com and Realtor.com. Use those figures as a rough guide.
- If a loan officer tries to over-value your home, fight the ego-driven urge to go along with it and try to find a rational approximation of its worth based on the above research.
Determining the value of your home is a whole other post topic that I’ll dive in to at some point. But for now, there you have it — the new bait and switch. It’s the newest way for loan officers to get you off the street with the promise of something too good to be true. It’s a very easy thing to fall for, but by knowing ahead of time what your home is actually worth you can keep loan officers from trapping you by feeding your ego with an inflated property value.
Franz @ Blue Collar Agents says:
Interesting perspective and you’ve hit on most of the places where lenders squeeze their clients.
The most common form of “bait and switch” I see is prequalifying borrowers for loan programs that they don’t actually qualify for, then when underwriting rejects them putting them into the more expensive program that they actually do qualify for.
The “old” tactics are alive and well, and unfortunately for every educated consumer out there, there’s another sucker who doesn’t know any better.
April 9, 2007 — 7:45 am
Brian Brady says:
Both Morgan and Franz point out two underhanded tactics practiced by some loan originators. The “overvaluing” and “best case scenario” bait and switch.
Consumers sometimes beg originators to lie when they insist on receiving a good-faith-estimate without credit, income, or value analysis.
April 9, 2007 — 8:26 am
jan says:
Was trying to do a refi (30 yr fixed to another 30 yr fixed, no cash out) on a property with Wachovia. It dragged on for weeks, then just before signing they increased the rate. I gave them income verification, have an excellent (805) credit rating, and thought I was dealing with a reputable company.. Fortunately I was able to just walk away.
April 4, 2008 — 7:37 am