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June 21, 2004
"I locked my 30-year FRM at 5.5% and 1 point,
but at closing I was dunned for $2800 in lender fees of various types that had
never appeared on the Good Faith Estimate. Why didn�t the lock protect me
against that?"
A lock is designed to protect borrowers
against a rise in price between the lock date and closing, but the protection is
often inadequate or fails altogether. You just discovered (the hard way) one of
the reasons.
In locks covering fixed-rate mortgages (FRMs),
most lenders include only the interest rate and points. (Points are an upfront
charge expressed as a percent of the loan amount.) They leave their fixed-dollar
fees out of the lock. Then, if the market goes against them -- they have to
close a 5.5% mortgage in a 6% market, for example � they can cover at least some
of their loss by jacking up their fees.
Based on past experience, the paragraph above
is going to elicit angry denials of the "we are a reputable firm and would never
stoop to such practices" variety. OK, if you would never stoop to such
practices, it will cost you nothing to include fixed-dollar fees in your locks.
Truth in Lending, administered by the Federal
Reserve, requires that lenders must display the APR whenever they display an
interest rate. The APR measures cost to the borrower and includes the rate,
points and fixed-dollar fees. All the Fed needs to do to eliminate fixed-dollar
fee abuses is to require that when lenders lock a rate, they also lock the
associated APR. Since the APR includes these fees, locking the APR is the same
as locking the fees.
When it comes to adjustable rate mortgages (ARMs),
the issue of lock coverage becomes even more complex, as illustrated by the next
letter.
"My ARM has been locked for about 53 days.
Yesterday the lender wrote and said the loan has changed from a 2/2/5 to a
5/2/5, though the rate remains locked until settlement next week. I have two
previous emails from the lender confirming the 2/2/5 caps. Aren�t the caps
locked with the rate?"
They should be, but obviously in this case
they were not. You have a legitimate beef and I would protest loudly and
strongly.
Most ARMs have two kinds of rate caps.
Adjustment caps limit the size of any rate change, and lifetime caps set a
maximum rate over the life of the mortgage. ARMs on which the initial rate holds
for 3 years or longer, have two adjustment caps: one applies to the first rate
adjustment and the other applies to all subsequent adjustments. A 2/2/5 means
that the initial adjustment cap is 2%, the subsequent adjustment cap is also 2%,
and the lifetime cap is 5% above the initial rate.
If they shift you to a 5/2/5, the initial
adjustment cap would be 5% rather than 2%. That will cost you a bundle if market
rates are substantially higher when the first rate adjustment comes around.
The general practice in locking ARMs is to
lock the initial rate, points, the margin (the amount added to the rate index on
a rate adjustment), and the maximum rate. These are viewed as components of the
"price" of the ARM, which can vary from borrower to borrower. As with FRMs,
fixed-dollar fees are not included.
Rate adjustment caps are not included in a
lock because they are considered to be part of the definition of the particular
ARM program, along with the term, rate index, initial rate period, subsequent
rate adjustment period, and sometimes other features. These do not change from
case to case, or from day to day, so there is no reason to include them in a
lock.
Changing the first adjustment cap on you
could mean that the loan officer mistakenly thought the cap was 2% when it
actually was 5%. Mistakes happen, but the lender should eat a mistake made by an
employee, not you. Alternatively, after you locked, the lender might have
decided to change the program definition by raising the first adjustment cap to
5%. He is entitled to do that but he is not entitled to apply the new program
definition to you because you locked the previous version of the program.
This episode suggests that it is prudent for
a borrower locking an ARM to have a written description of all the features of
the ARM, whether they are part of the price or not. Such a list is provided at
Information
Needed to Evaluate an ARM.
Copyright Jack Guttentag 2004
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