By Jack Guttentag
Saturday, April 19, 2008
One of the unpleasant aspects of the mortgage crisis has been the volatile cost of credit.
Interest rates have swung widely this year. For example, the wholesale rate on 30-year, fixed-rate mortgages rose from 5.23 percent Feb. 6 to 6.16 percent Feb. 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 from wholesale price data collected for my Web site.)
Increased volatility means more letters to me from borrowers who have rate-lock problems. A lock is an agreement between the lender and 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 in when the rate was high, and when it falls, they ask 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 in when the rate was low, but when it rose, the lender refused to honor the commitment. Or so the borrowers were told by their brokers. In my experience, in most such cases the broker is the culprit.
Usually, lenders stand by their locks -- their reputations are at stake. Further, walking away from a lock antagonizes the loan officer or broker, who will be shut out of his or her 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 that 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.
Mortgage brokers can play Dr. Jekyll or Mr. Hyde in the locking process. The good 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 as soon as possible. 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 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 vs. a shorter lock period but leaves the final decision to the borrower.
Mr. Hyde, in contrast, plays 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 expandable. He has an incentive to select the shortest possible lock period because the price saving will go to him rather than to the borrower. If the borrower loses the lock because the loan doesn't get closed in that period, Mr. Hyde will blame the lender, real estate agent or someone else.
The worst game played by Mr. Hyde is telling the borrower the loan is locked when it really 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 a variety of explanations 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 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. That 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, too.
Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site, http://www.mtgprofessor.com.
© 2008 Jack Guttentag
Distributed by Inman News Features