Banks Are Latest Industry to Try Optimized Pricing

But a funny thing happened on the way to closing the deal on his first home. After reviewing his application, he says, a Bank of America representative offered him a rate of 6.5%, nowhere near as good as the 5.8% to 6.2% rates he had been quoted from other lenders. And the difference wasn't lunch money: Had he gone with Bank of America (BAC), his mortgage payments, over the life of the loan, would have cost an extra $21,000 more than the deal he ultimately accepted. "They were higher than anybody, and I don't know why," he says of his branch's offer.

For its part, Bank of America declines to discuss its offer to Mathur or the details on how it makes such decisions. But ask a financial-industry consultant and he'll tell you what may have been going on: something called price optimization. That's a fancy way of saying Mathur's rate was partially based on what the bank's computer thought he might be willing to pay. Sound familiar? Yes, banks have started to play the same elaborate — and convoluted — pricing game that airlines, hotels and a host of other industries have perfected, charging customers different prices for an identical product or service. Only what's at stake isn't a one-way ticket to Phoenix that might cost one customer $80 and another $800, but some of the largest financial transactions most folks will ever make: mortgages, car loans and home-equity lines of credit.

The move to price optimization, which most banks are still only testing, has been spurred by the mammoth challenges threatening the $6 trillion lending industry. Subprime lending losses contributed to a 45% drop in bank earnings last quarter, and mortgage-loan volume is expected to tumble 16% this year. Analysts say banks are looking to price optimization as a relatively quick and easy way to boost a sagging bottom line by as much as 5 to 10% in three to six months. "The return on investment is huge," says Terry Kuester, a banking consultant with Deloitte & Touche. "It's a huge opportunity for banks."

When airlines first moved to this sort of high-tech pricing in the '80s, consumers howled. Though optimization led to lower fares for some, fliers argued it smacked of price gouging, because fares go up when people need to travel the most, like during holidays and school breaks. But in the case of loans, customers will only be able to guess when the bank is swapping in higher rates. "I think it's terrible," says Merrick, N.Y., mortgage broker Robert Bram. "I don't believe anyone should be charged a higher rate just because they aren't as rate-conscious as the next guy."

THERE IS, OF COURSE, nothing new about banks offering different rates to different customers; lenders have long used sophisticated statistical models to set higher rates on risky loans made to customers with bad credit. But now, says TowerGroup consumer-lending analyst Bobbie Britting, banks are turning all that statistical firepower toward sniffing out profit-boosting opportunities. Most won't discuss or confirm the practice, but insiders say Wachovia (WB) and Washington Mutual (WM) are using the technology to set rates on home-equity loans, and Citibank (C) is testing its own in-house version of the technology. Bank of America, meanwhile, has experimented with mortgage loans, and big auto lenders like Ford Motor Credit and AmeriCredit (ACF) are using it to help price car loans.