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by Megan Barnett

(IDG) -- Internet entrepreneurs forced dramatic changes in the brokerage industry. Now they have their eyes on another huge segment of the financial landscape: home mortgages.

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People hate shopping for mortgages. Getting the best rates requires multiple phone calls to banks, finance companies and mortgage brokers. You tell your story repeatedly, answer standard questions over and over, weigh countless options and ultimately decide on a lender. And that's just the beginning. You still have to endure one of the most paper-intensive and tedious of all financial transactions. The lender asks for piles of old financial records. You FedEx signed documents back and forth and spend hours on the phone with your mortgage processor. It is an old-world, offline horror.

Chris Larsen and Janina Pawlowski started thinking about how to improve the painful process several years ago, when they were running the Palo Alto Funding Group, a mortgage brokerage in Silicon Valley. Why not let the Internet automate some of the work, they wondered, freeing up time and reducing the costs of shopping and processing loans? In 1996, Larsen and Pawlowski left Palo Alto Funding Group and formed a Dublin, Calif., company called E-Loan.

"We wanted to create a loved brand for a process people hate," says Larsen, CEO of E-Loan.

To help take a step in that direction, E-Loan this year hired Joseph Kennedy as senior VP of marketing and business development. Kennedy had led the successful brand strategy for the Saturn division of General Motors. No doubt E-Loan's profile will get an additional boost from publicity surrounding its pending IPO. In March, E-Loan filed with the Securities and Exchange Commission to raise up to $55.2 million in an offering led by Goldman Sachs and Donaldson Lufkin & Jenrette.

E-Loan is the market leader in online mortgages, but the game is young, and more players are entering the fray. The competition includes both other Web startups and big offline lenders like Countrywide. With such high stakes, the list will only get longer. By one estimate, the Web's share of the $1.5 trillion mortgage market will grow from less than 1 percent in 1998 to 25 percent by 2003.

The online mortgage industry is divided into two camps. One group uses a referral model, while the other processes loans internally. Intuit's QuickenMortgage, Microsoft's HomeAdvisor and LendingTree use a referral model. E-Loan, iOwn (formerly HomeShark) and Mortgage.com do their own processing. Referral firms are essentially marketplaces. They deliver quotes from lender partners and get paid upon delivery of new customers. Processors like E-Loan employ small armies of customer-service representatives who handle the paperwork and correspondence needed to close a loan.

Whether the industry has room for both camps is an unanswered question. "If you're a marketplace, it's almost like you're too neutral," asserts E-Loan's Larsen. "With that model, you have to keep banks and consumers happy. In fact, all you really have to do is keep consumers happy." Larsen describes E-Loan as a "consumer advocate" rather than a marketplace.

Intuit's QuickenMortgage, a close second in the market behind E-Loan, is still debating internally about whether the referral model will survive. "I think the jury's still out," says Alison Wagenfeld, group product manager for QuickenMortgage. "We've been evaluating the issue and haven't found that one model has a distinct advantage over the other."

Last September, Intuit was reportedly set to acquire E-Loan. But, at the last minute, the company accepted an equity investment from Yahoo.

The fact that most major mortgage lenders are partnering with the online sites can't make it easy for the referral model. For instance, Chase Manhattan provides rates for E-Loan, iOwn, HomeAdvisor and QuickenMortgage. While the same rate could be returned from Chase on each site, two of those sites will send you elsewhere to have your loan processed. The others will process it for you directly.

For E-Loan, simply processing and closing the loans wasn't enough. The gap between consumers and the Wall Street players who ultimately control the mortgage market was still being bridged by offline mortgage banks. Nine months ago, E-Loan made an aggressive push to assume that role, too.

E-Loan has since registered as a mortgage bank in 34 states, and it's working on the other 16. The company does more than just process loans. It's also in the market of funding loans at wholesale prices from a line of credit and then reselling them on the secondary market. The approach has opened a new channel of revenue for E-Loan.

One issue is whether or not the consumer can count on getting the lowest rate from E-Loan, which now has an incentive to sell loans it has marked up from wholesale.

"They [E-Loan] will show you the lender they want to show you," argues Cameron King, executive VP of e-commerce for Countrywide Home Loans. "They'll quote the loan that gives them the best markup." Countrywide is in a similar business, acting as a wholesale lender and online broker for its own loans. Interestingly, Countrywide also sells its loans through E-Loan and buys loans from it on the secondary market.

While E-Loan doesn't automatically return all a homeowner's mortgage options, it provides links to see them all. The company partners with over 70 lenders offering roughly 50,000 mortgage products in aggregate, so displaying all options wouldn't exactly make it easier for the consumer.

Moreover, becoming a mortgage bank won't necessarily guarantee E-Loan's lead in the market. Acting as a wholesale lender has its risks, particularly in a volatile interest-rate environment in which there is no guaranteed base of mortgage buyers.

During the past six months online mortgage providers have begun to climb the crest of the online wave, while interest rates have declined steadily. Falling rates prompt just about every mortgage holder to at least consider whether to trade up or refinance. These sites have made it easy to window-shop for loans – and a portion of those window-shoppers turn into buyers.

But just as the bull market will someday retreat, mortgage rates will eventually turn north again and lead to an inevitable shakeout in the online lending market. In the mean time, lenders continue to climb over one another to get in the game.