Locking the Loan

Locking the Loan

An option exercised by the borrower, at the time of the loan application or later, to “lock in” the rates and points prevailing in the market at that time.

When lenders “lock,” they commit to lend at a specified interest rate and points, provided the loan is closed within a specified “lock period.” For example, a lender agrees to lock a 30-year fixed-rate mortgage of $200,000 at 7.5% and one point, good for 30 days.

The Need for Locking: The need for locking arises out of two special features of the home loan market: volatility and process delays. Volatility means that rates and points are reset each day, and sometimes within the day. Process delays refer to the lag between the time when the terms of the loan are negotiated, and the time when the loan is closed and funds disbursed.

If prices are stable, locking isn't needed even if there are process delays. If there are no process delays, locking isn't needed even if prices are volatile. It is the combination of volatility and process delays that creates the need for locking.

For example, Smith is shopping for a loan on June 5 for a house purchase scheduled to close July 15. Smith is comfortable with the rates and points quoted on June 5, but a rate increase of 1/2% within the following 40 days could make the house unaffordable, and Smith doesn't want to take that risk. Smith wants a lock, and lenders competing for Smith's loan will offer it.

Cost of Locking to Lenders: If locks were equally binding on lender and borrower, locks would not cost the borrower anything. While lenders would lose when interest rates rose during the lock period, they would profit when interest rates fell. Over a large number of customers they would break even.

In reality, however, borrowers are not as committed as lenders. The number of deals that don't close, known as “fallout,” increases during periods of falling rates, when borrowers find they can do better by starting the process anew with another lender. Fallout declines during periods of rising rates.

This means that locking imposes a net cost on lenders, which they in turn pass on to borrowers. The cost is included in the points quoted to borrowers, which are higher for longer lock periods. The lender who quoted 7.5% and one point for a 30-day lock, for example, might charge 1.125-1.25 points for a 60-day lock.

Controlling Lock Costs: Years ago, lenders controlled lock costs by requiring borrowers to pay a commitment fee in cash. The fee was returned to them at closing but forfeited if they walked from the deal. But today, commitment fees have mostly died out. Borrowers don't like them, and lenders and mortgage brokers don't want to place themselves at a competitive disadvantage by requiring them.

To control lock costs today, many lenders refuse to lock until borrowers demonstrate commitment to the deal by completing one or more critical steps in the lending process. This may include submission of a completed application along with an appraisal and credit report. But some lenders will lock based on submission of only an abbreviated lock request form.

Lenders who make it difficult to lock will have lower fallout and may therefore offer better prices, but the locking delays that arise from their requirements impede effective shopping. Lenders who make it easy to lock have large fallout costs but they allow borrowers to shop and lock in a short period.

A mortgage shopper needs to know what each lender requires to lock, and how quickly the process can be completed if the shopper does his or her part. A good mortgage broker can help enormously. Brokers know lender lock requirements, can help expedite the process, and will keep the lender honest if the market changes during the lock process.

Choosing When to Lock: Borrowers developing a lock strategy should forget about trying to guess the direction of interest rates. Interest rates are not predictable.

The first thing borrowers should consider is their capacity to take the risk of a rise in market rates. If they barely qualify at today's rates and an increase would knock them out of the market, or force them to accept other unfavorable terms, they should lock ASAP.

If they can withstand a rise in rates, and are confident that the loan provider will offer the true market price when they finally lock, there is a benefit in delaying it. As noted above, the price is lower for shorter lock periods because the lender takes less risk with a shorter lock. This means that if market interest rates don't change, the lock price will fall as the lock period shortens.

Borrowers can only capture this benefit, however, if the market price quoted to them when they finally do lock, is accurate.
Borrowers will know that the price is accurate if they can access the price on the lender's Web site, or are dealing with an “Upfront Mortgage Broker.” (They give you the best price quoted by their wholesale lenders and will show you the price sheets.) They won't know, and should expect the worst, if the market price on the lock day is what the loan provider says it is over the telephone. In that event, “lock ASAP” remains the best advice.

This is particularly the case with home purchasers, who lose the ability to walk away from their loan provider as the closing date approaches. Borrowers who are refinancing can always change loan providers if they get a fast shuffle on the lock day.

Paying for Insurance You Don't Get: Borrowers who lock through mortgage brokers are exposed to a special hazard: the broker may inform the borrower he is locked but actually allows the rate to float. If the market is stable, the broker can pocket the difference between the lock price quoted to the borrower and the price at which the loan is finally locked. This scam, and how to avoid it, is discussed in Mortgage Scams and Tricks/Strictly Broker Scams/Charging for a Lock Without Locking with the Lender.

Is the Borrower Committed Under a Lock? I have changed my position on this question. Originally my view was that borrowers were committed. Now my view is that borrowers can't be held to a commitment they don't make. If lenders lock at their own risk to get the borrower's business, lock-jumping is just another cost of business.

The prevailing practice of brokers and lenders is to leave the borrower's commitment under a rate lock unstated. They want borrowers to consider themselves committed by rate locks. However, they fear that if they ask the borrower for a written acknowledgement of commitment, the borrower might be frightened into the arms of another loan provider who didn't require it. This is the same reason that loan providers don't require a commitment fee that borrowers would lose if they jump the lock.

If the borrower's commitment under a rate lock is left ambiguous, then the borrower is entitled to interpret that ambiguity as he or she pleases. Lock-jumping is OK, in other words, unless the borrower acknowledges in writing that it is not OK.

Lock Versus Float-Down: Where a lock freezes the rate and points, a float-down freezes them only in the event that market rates increase. If they decrease, the rate under a float-down will decline correspondingly.

Since a float-down carries more value to the borrower than a lock, and is more costly to the lender to provide, it carries a higher price. For example, a lender who charges one point to lock the interest rate for 60 days might charge 1.5 points for a 60-day float-down.

The exact terms of float-downs vary from lender to lender. Questions to ask include: when can I exercise, how often can I exercise, is there any minimum price reduction for exercise, and how is the current market price communicated to me? If the market price is what the loan provider says it is over the telephone, the borrower is vulnerable to being scammed.

To avoid being scammed, borrowers should ask the loan provider to agree to show the price sheet with the relevant price circled, at the borrower's request, anytime within the exercise period. A Web site that clearly identifies the price niche into which the deal falls is even better.

Locking the Rate but Not the Points: Since the interest rate and points are two dimensions of the price, locking only one makes no sense. It is the equivalent of locking the price of a box of doughnuts but not the number of doughnuts in the box.

Lock Expirations: Sometimes locks expire before the loan can be closed. There are many possible reasons why the work does not get done on time. When this happens, lenders typically will extend the lock period only if interest rates have not increased. If rates are higher, they will relock at the higher rate.

The only situation where a lender will extend a lock when interest rates have risen would be where the lender acknowledges that he or she is solely to blame for the delays that caused the lock expiration. This does not happen very often. Typically, there are too many people involved in the process for the lender to assume full responsibility. These include the borrower, mortgage broker, appraisers, escrow agents, and others.

Deals that don't get done on time are more likely to be refinances than home purchases. Lenders generally give purchasers a priority. Delayed refinancings can be rescheduled, but not completing purchase mortgages on time can jeopardize the deals, at high cost to buyers. It could also jeopardize lenders' relationships with real estate brokers, upon whom many depend for borrower referrals.

Here are some tips for minimizing the chances of a lock expiration:

• When you select the lock period at the beginning, ask how long the lender's current turn-around time is. Lenders usually report this to mortgage brokers every day on their price sheets. During a refinance boom, it makes sense to add 15 days more than you think you need.

• Be sure you know all the documents needed by the broker or lender, and assemble them so they can be produced when

• Be available to answer questions or provide additional documents during the entire period the loan is in process, and respond to questions in a timely manner.

• Stay on top of the mortgage broker, who should be the key coordinator of all players. In interviewing the broker at the outset, seek assurance that he has the time to handle your deal effectively. Deals from harassed brokers who take on more than they can handle effectively, are most likely to languish in the lender's pile of incomplete applications.

Recourse When Locks Expire That Shouldn't: When interest rates spiked in July-August 2003, my mailbox was suddenly flooded with messages from frustrated borrowers whose locks had expired. In some cases borrowers held the broker responsible, in other cases the lender, but they all ended with the same question to me: “What is my recourse?”

In cases where the broker informed the borrower in writing that the loan was locked but did not lock with the lender, it would be relatively easy to prove the broker's culpability. (If the broker told the borrower the loan was locked but did not commit it to writing, it would be one recollection against another.)

Obtaining a court judgment and then collecting from a broker, however, is another matter. It might work against some substantial broker firms, but many brokers are individual operators who may be here today and gone tomorrow.

Lenders who allowed locks to expire by deliberately slowing down the process are more attractive targets for a lawsuit, but proving their culpability in any individual case is difficult. Lenders can claim that the borrower should have selected a longer lock period, or that the borrower was slow in meeting the lender's reasonable requests for information. They can also claim that unforeseen circumstances for which they are not responsible slowed down the process. Hence, filing an individual suit against a lender is not likely to provide redress.

Borrowers can and should make their case to the lender's regulatory authority. If the authority receives a large number of such complaints, they might audit the lender's operations to see if there was an actual policy in place to accelerate the number of lock expirations. Class action lawyers might also get wind of the complaints, and initiate an action that will force the lender to provide information that would not be obtainable in any individual action. Even if this provides little redress to the borrowers who were hurt, it can send a useful message that may help the next cohort of borrowers.

The Mortgage Encyclopedia. Copyright © 2004 by Jack Guttentag. Used with permission of The McGraw-Hill Companies, Inc.