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May 4, 1998
"A lender I solicited
offered me a �free� 60-day rate lock. What exactly does that mean? I am
always suspicious of anything that is offered free."
A rate lock probably has value to
you but you are right to suspect that it is not being given away free.
Capital markets today are extremely
volatile. Mortgage markets are a part of the broader capital markets and share
in the volatility. Most mortgage lenders set their rates each morning, but if
markets change in a major way during the day, they may send new rates to their
employees and mortgage brokers immediately -- by telephone, fax or through an
electronic network.
Because many borrowers would like
to pin down what they are going to have to pay, lenders offer protection against
the risk that the rates and points will change between the time they apply for a
loan and the time the loan is closed. This protection is called a
"lock". The lender "locks-in" the quoted terms for a
specified period, protecting you against the possibility that rates increase
during that period.
On home purchase transactions, the
lock-in period ranges generally from15 to 90 days. In cases where a home is
being built, however, it may be longer, while on refinance transactions it may
be shorter. If the loan is not closed within the stipulated period, the
protection expires and you either have to accept the terms quoted by the lender
on new loans at that time, or start the shopping process anew.
If you elect not to take lock-in
protection, the rates and points "float", meaning that they change
daily with the market. In this case you end up paying the rates and points
prevailing at the time the loan closes, which could be higher or lower than they
were when you started the process.
A lock-in should thus be viewed as
an insurance policy, with your need for it based on whether or not the insurance
premium you pay for the lock is worth the risk. If you barely qualify for the
loan you need at current rates, so that a rate increase might force a major
change in your plans, a lock is cheap insurance.
Locks are risky to lenders and the
risk is greater as the lock-in period gets longer. If interest rates rise, a
locked loan will usually close at a loss to the lender, but if rates decline
many borrowers will seek a lower rate by starting the process over again with a new lender.
Losses to the lender from rising rates, therefore, are not
offset by gains from falling rates. For this reason, and this confirms your
suspicions, lenders always charge for a lock.
The charge, however, may not be
explicit. If a lender offers a "free 60-day lock", for example, it
means that the lender has bundled the insurance premium on a 60-day lock into
the price of the loan. Most lenders follow this practice, but the period for
which the "free" lock holds varies from lender to lender. Some will
provide a "free lock" for only 15 days, which means that they have
bundled a smaller insurance premium into the price.
The bottom line, therefore, is that
you will usually get the best deal from the lender who offers the
"free" protection that corresponds to your needs. If you only need
protection for 30 days, dealing with a lender who will cover you for 60 days
means that you are paying for more insurance than you need. If this turns out
not to be the case � if the 60-day quote from one lender is actually better
than the 30-day quote from another � continue shopping among lenders offering
free 30-day locks, because you probably can do better.
Copyright Jack Guttentag 2002
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