One of the unpleasant features of the mortgage crisis has been heightened volatility in the prices faced by borrowers. For example, the wholesale rate on 30-year fixed-rate conforming mortgages rose from 5.23 percent on February 6 to 6.16 percent on February 26, dropped to 5.65 percent on March 3, rose to 6.23 percent March 6, dropped to 5.38 percent March 20, and rose to 5.812 percent April 2. These numbers are drawn from the wholesale price data shown daily on my Web site.
Increased price volatility invariably means an influx of letters from borrowers on lock problems. The lock is a mutual agreement by the lender and the borrower that their transaction will be at a specified price. Looking ahead, both are protected — the borrower against a rise in rate, and the lender against a decline.
Broadly, my letters from borrowers fall into two groups. One group locked when the rate was high, and now that it is lower they ask any or all of the following questions: are they committed ethically (yes); how can they get out of the commitment (by relinquishing any fees they have already paid); and can they induce the lender who locked their rate to reduce it (no)?
The second and much smaller group locked when the rate was low, now it is higher and the lender has refused to honor its commitment. Or so they have been told by their broker. In most such cases, the broker is the true culprit (see below).
Usually, lenders stand by their locks, because their reputation is at stake. Further, walking away from a lock antagonizes the loan officer or broker involved in the deal, who will be shut out of their commission if the loan doesn’t close. Lenders do renege on occasion, usually when many deals, a lot of money, and perhaps the firm’s solvency are at stake, but it is man-bites-dog news.
When borrowers renege, in contrast, it is dog-bites-man. A pervasive attitude is that the lender should stand by the lock if rates increase, but borrowers should be free to look elsewhere if rates decrease.
To some degree, lenders are responsible for this. Because they fear losing business, they don’t press borrowers to recognize that they are committed by a lock, and they don’t much penalize borrowers who walk away when rates decline. Usually, the borrower will lose no more than $500, the cost of an appraisal and credit report, which is not much of a deterrent if the rate drops significantly after the lock.
Mortgage brokers can play Dr. Jekyll or Mr. Hyde in the locking process. Dr. Jekyll explains the lock process to the borrower, including the borrower’s obligation. Dr. Jekyll never tries to forecast interest rates, always advising the borrower to lock ASAP. And Dr. Jekyll passes through the lock statement as soon as it is received from the lender.
Dr. Jekyll also uses his experience and judgment to advise the borrower on how long the lock period should be. The borrower doesn’t want a longer lock period than is needed because each 15-day extension raises the price. On the other hand, if the deal doesn’t close within the lock period, all protection against a rate increase is lost. Dr. Jekyll explains the cost and risk of a longer versus a shorter lock period, but leaves the final decision to the borrower.
Mr. Hyde, in contrast, likes to play games that may increase his fee. In contrast to Dr. Jekyll, who charges a set fee for his services and passes through the price from the lender, Mr. Hyde’s fee is unstated and expansible. He has an incentive to select the shortest possible lock period because the price saving will go to him rather than the borrower. If the borrower loses the lock because the loan doesn’t get closed in that period, Mr. Hyde will blame the lender, Realtor, or someone else.
The worst game played by Mr. Hyde is telling the borrower the loan is locked when it isn’t. If rates go down, Mr. Hyde can get a better price than the one promised to the borrower. The benefit may be shared with the borrower on a refinance, but on a purchase where the borrower is committed, Mr. Hyde will keep it all.
If rates go up, Mr. Hyde has an array of excuses for losing the lock, most of which involve blaming the lender. That’s why borrowers should accept no excuses for not being provided with the lock statement from the lender.
Another game that Mr. Hyde plays is to offer to lock with one lender as protection against a rate increase, while applying to a second lender, without locking, in case rates drop. This makes an attractive pitch to the borrower, but don’t buy it. Brokers who play this game are scamming their lenders, and they will find a way to scam you as well.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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