Loan rates have been as staccato as the stock market. After the longer process of loan approval, when do you lock the loan rate? Will your 6.5 percent fixed-rate loan go up if you don’t lock it today or should you gamble on the hope of a possible tick downward?
There was a time, not long ago, when rate locks were not a part of the conventional loan package. Borrowers had to pay for a lock, in addition to the loan origination fee.
When mortgage interest rates were well into double digits, the offer of a paid-for rate guarantee made a lot of sense … especially in the days when a borrower could qualify for a 30-year, fixed-rate loan at 12.5 percent but did not have the income for the same loan amount at 13 percent.
While the genesis of loan locks can really be traced to the high-flying rate days of the 1980s, the quasi-insurance instrument has traveled a variety of roads. It has been used as a recruiting tool for lenders, a safety net for builders who could not finish homes on time, and a smokescreen for some consumers who wanted the lock honored only when rates went up, not down.
Initially, a rate lock was self-explanatory — the borrower had the opportunity of securing today’s rate for 30, 45 or 60 days down the road. It was an easy decision in a market that seemingly was always on the rise because the borrower had the lender’s pledge that the interest rate would be the one you "locked" (and often paid for) when you applied. For example, if you received an 8 percent, 30-day lock and closed on time, the rate would be 8 percent at closing.
The borrower always had the option of "floating" with the market, thereby gambling that the rate at closing would either be lower than the rate at application or not worth the price paid for the lock (often one half of one percent of the loan amount). If rates rose dramatically, some unscrupulous lenders would drag their feet and prolong the closing so that the loan lock would expire. The agreement from the start was if the loan was not closed on time and was not the fault of the lender, all bets were off. The unhappy borrower was then forced to take a higher rate in order to finance the home.
But lenders were not the only ones who failed to honor rate locks. In September 1991, when interest rates began to dip under 9 percent for the first time in four years, borrowers who locked in at higher rates suddenly were behaving like superstar athletes attempting to renegotiate their contracts at midseason. Borrowers who had yet to sign on the dotted line suddenly went seeking a better deal.
What consumers did not want to understand was that the lenders actually had made a commitment to the secondary market when the initial lock was secured. Much like a stock or bond, the lender was telling the market that he had a loan committed at a specific price.
Residential loan executives were receiving three to four calls a day from people who had locked and then wanted a lower rate. They first tried to determine if the lending bank had handled the loan in a timely fashion. If so, some lenders released borrowers from their loan lock, yet kept a portion of the origination fee. Borrowers were then free to seek a better loan rate. Depending on the deposit, it was often financially prudent to stay with the same lender.
It was a curious time in mortgage lending. There were nasty tales of bait-and-switch tactics by lenders. However, consumers knew that most banks would honor their locks if rates went up, yet borrowers still wanted the option of getting a lower rate if rates came down. The situation gave way to "downside protection" with lenders giving consumers exactly what they wanted.
Now, even though borrowers have fewer options than they did a year ago and qualifying is more difficult, competition continues for good borrowers who can qualify for fixed-rate loans. While lenders handle locks differently, some long-term lock programs have evolved into a no-cost "ceiling" where the lender guarantees the rate will be "no higher than" the agreed-upon locked rate, yet possibly lower.
Given the crazy markets, economists are leery of predicting long-term rates. We should know more in this week when housing analysts gather for the annual Realtor convention in Orlando, Fla. However, if you agree to a loan — either with a rate lock or a rate float — do your best to hold up your end of the deal.
To get even more valuable advice from Tom, visit his Second Home Center.
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