December 15, 2003
have lock failures increased recently?
lock failure occurs when a lender does not honor a mortgage price that a
borrower had believed was guaranteed. Lock failures occur when interest rates
are rising and honoring locks is costly to lenders. The bulge in lock failures
in recent months reflects an increase in interest rate volatility, relative to
market interest rates are stable or declining, locks are always honored because
it doesn�t cost lenders anything to do so. If a lock expires because the loan
could not be fully processed within the lock period, the lender will extend it.
In a rising rate market, however, expired locks will be extended only at
the new market rate.
saying that mortgage lock failures result from rising interest rates is like
saying that the failure of a casualty insurance company to pay off on a fire was
a result of the fire. Mortgage locks are supposed to protect borrowers against
rising interest rates. The fact that the protection often fails reflects
weaknesses in the lock system.
are mortgage locks so unreliable?�
reason is that the adverse event that triggers the insurance � a rise in
interest rates �affects every locked loan in lenders� pipelines.
In contrast, the adverse event that triggers homeowner insurance is
usually an isolated event. One
house fire will not seriously damage a casualty insurance company, but a rise in
interest rates can force a lender who is not adequately hedged into insolvency.
lenders hedge against a major hit to their profitability from rising rates.
They hedge by executing transactions that will increase their profits
when rates increase, offsetting their lock losses. A lender who is fully-hedged would not be affected by a rise
in rates, but since hedging is costly, few lenders are fully hedged.
long period of declining interest rates weakens the lock system. Hedging during
such a period is money down the drain, so lenders are tempted to do less of it.
And a few may actually adopt a �go-for-broke� policy where they don�t
hedge at all. They look to make as much money as they can during the low-rate
period, and go out of business when it ends, leaving failed locks behind.
Indeed, a significant proportion of the failed locks in 2003 can be traced to
one large lender who evidently pursued such a policy. When it closed its doors,
hundreds of borrowers were left stranded.
weakness of the lock system is that some borrowers, especially among those
refinancing, game the system. They lock the price with a lender, but if rates
decline, they lock again with another lender. This practice raises the cost of
locking, pushing lenders to find ways to protect themselves.
lenders try to protect themselves against this practice by charging a lock fee
that is credited back to the borrower at closing but is not refundable if the
borrower walks from the deal. Or
the lender may insist that the borrower pay one or more fees, such as an
appraisal fee, that the borrower would have to pay again if he went with another
lender. These are fair conditions, but lenders who impose them place themselves
at a competitive disadvantage, so they are far from universal.
less savory practice that underlies many lock failures is to load the loan
approval with conditions that allow the lender to back out. Every lock is
conditioned on the borrower being approved for the loan, and approval is
frequently subject to conditions. Most of these are completely reasonable, for
example, the removal of a lien on the property.
But some conditions are designed to allow the lender to exit the lock
recently heard of an interesting one from a puzzled borrower. His commitment
letter stated that if the loan application, which the lender had approved, was
rejected by the investor to whom the lender intended to sell the mortgage, the
lender�s lock was no longer valid. This borrower was alert, caught the
condition, and asked me what I thought about it. I told him that it was the
lender�s responsibility, not his, to determine whether he met the investor�s
requirements. The lender removed the condition.
lenders would rather protect themselves with contractual escape clauses rather
than charging a non-refundable fee because they know that most borrowers don�t
read contracts but fees drive them away. Other things the same, smart borrowers
should prefer lenders who charge a non-refundable lock fee.
Lenders who protect themselves from being gamed in stable and declining
rate markets are more likely to honor their locks in a rising rate market.
working with a mortgage broker, as opposed to dealing directly with a lender,
increase or decrease the probability of a lock failure?�
can go either way.
advantage of dealing with a broker is that brokers have the same interest as
borrowers in avoiding lenders who dishonor locks.
Brokers won�t use wholesale lenders whose lock commitments include
escape clauses that let them off the hook in a rising rate market.
Were this to happen, the borrower might well blame the broker.
brokers cannot monitor how well lenders manage their finances. The single worst
episode of dishonored locks in 2003 resulted from failure of a wholesale lender.
The brokers caught up in this failure were forced to find new lenders and
structure new deals for borrowers who could afford the higher rates; in many
cases they shaved their commissions, sometimes to zero, to make the new terms
less onerous for the borrower.
borrowers who deal with brokers have some protection against gamesmanship by
lenders, they are vulnerable to gamesmanship by brokers.
Having a third player in the picture, furthermore, can obscure the chain
of responsibility, to the borrower�s disadvantage. Brokers and lenders can and
do blame each other for failed locks.
on balance the broker increases or decreases the chances of a failed lock
depends very much on the individual broker.
efficient/honest broker guides the borrower in selecting a lock period
long enough to process the loan, but no longer, since longer lock periods cost
more. (A lock for 30 days will cost about 1/8 of a point more than a lock for 15
days, or $125 on a $100,000 loan; a lock for 60 days might cost $375 more).
broker knows how long each lender is taking to move loans through its pipeline,
and performs his part of the loan processing in a timely manner.
He submits complete and accurate
files that minimize the time it takes the lender to approve the application, and
keeps tabs on
the lender�s progress. The prices this broker locks will almost certainly be
honored, unless the lender fails, a contingency no broker can control.
sloppy broker doesn�t properly
inform the borrower how much time is needed, and/or fails to process the loan in
a timely manner, perhaps because he is over-committed. If interest rates are
rising and the lender is looking for an excuse for not closing within the lock
period, this broker will provide it.
deceitful broker doesn�t lock the loan with the lender, but tells the
borrower he has. The lock is a
fake. The broker�s intent is to
pocket the price premium for a longer lock period. If the 60-day lock price is
3/8 of a point higher than the 15-day price, for example, and if the market is
stable over the 60 days, the extra 3/8 of a point goes to the broker rather than
to the lender.
rates increase just a little, the broker might take the loss himself �
that�s how they rationalize what they do.
But if rates increase a lot, the broker runs for cover and the borrower
is left holding the bag.
this happens, as it did earlier this year, the deceitful brokers run in all
directions looking for excuses. The most common excuse is that the lock lapsed
because of the lender�s failure to process the loan within the lock period. Divided responsibility provides a cloak for the deceitful
broker to hide behind.
borrowers have any recourse for failed locks?�
is seldom a cure for failed locks.
Proving the culpability of lenders who deliberately allow locks to expire, is
extremely difficult. Lenders can claim that the borrower should have selected a
longer lock period, that the borrower was slow in meeting the lender�s
reasonable requests for information, that the broker submitted an incomplete
file, and on and on.
recourse against brokers may be even more difficult. How do you prove that
failure to close within the lock period was due to the broker�s carelessness
rather than to a deliberate slow-down by the lender? If a deceitful broker puts
a lock in writing, you can take him to small claims court, but if all you have
is oral assurances, forget it. Focus on prevention.
can a borrower do to prevent lock failure?�
failures can usually be prevented. The
key is in the selection of the loan provider.
If you are dealing directly with a lender, the greatest risk is a lender
who was not around before the most recent period of heavy refinancing.
A lender who entered the market to take advantage of a refinancing boom
is not a good bet to honor locks in a rising rate market.
always nice to have, but they aren�t much use in preventing lock failure.
The lender trying to make as much money as possible in a favorable market
will meet commitments and get good references so long as the market stays
favorable. The question is, what
happens when the market turns bad? The
only references of any value are those from borrowers who had locks that were
honored despite a rise in market rates after the lock date.
should also check the lender�s lock requirements, which vary widely.
Some charge nothing and require submission of a limited amount of
information. Others charge a fee
that is returned to the borrower only if the loan closes or if the borrower is
rejected. A �lock-jumper� who
bolts in search of a better deal elsewhere, loses the fee.
Such lenders may also require submission of a full application and
perhaps other documents such as an appraisal.
the tougher the lenders� lock requirements, the more likely that the lender
will honor a lock in a rising rate market.
Lenders who turn away business in stable/declining rate markets by making
it difficult for lock-jumpers are demonstrating that they expect to be around
for a long time.
should also examine the lender�s commitment letter with care.
The letter almost always specifies conditions that the borrower must
meet, the only question being whether the conditions are reasonable.
Requiring that homeowner insurance and title insurance be in place is
reasonable; requiring that the borrower�s application must be acceptable to
the investor to whom the lender intends to sell the loan, is not reasonable.
deal with mortgage brokers can usually depend on the broker to select a reliable
lender. The borrower�s focus
should be on selecting the right broker. A
particular concern is avoiding deceitful brokers who offer fake locks.
A fake lock
arises when the broker tells the borrower the loan is locked with the lender,
when it isn�t. If market rates
don�t increase, the broker pockets the difference between the price quoted by
the lender for a 30, 45 or 60-day lock period, and the price quoted for delivery
in a few days. If rates increase
just a little, the broker may honor the lock at his own expense.
If the increase is substantial, the broker runs for cover and the
borrower is stuck without a lock.
this, borrowers interviewing brokers should indicate that they expect to see a
written lock confirmation from the lender shortly after a lock is submitted.
Upfront Mortgage Brokers will provide this as a matter of course.
a sloppy broker who may not get your loan processed within the lock period is
more difficult. Many brokers will
never turn down a prospective client, no matter how many they already have.
Their view is that in a highly cyclical business, they have to make their
money when they can. In addition,
they never know how many of their prospective clients will remain with them
through closing and how many will go elsewhere.
you want is a broker who plays hard-to-get in order to avoid wasting time on
borrowers who don�t stay the course. These
brokers require that borrowers make a commitment to them.
This might be a contract making the broker the borrower�s exclusive
agent in securing a loan, or it might be a requirement that the borrower pay one
or more fees in advance.
is the broker you want, but you don�t commit yourself without the broker
committing to you. That means an
agreement, in writing, on the broker�s total fee, including any payment to the
broker from the lender. (This is
called a �yield spread premium�). Upfront
Mortgage Brokers do this as a matter of course, but other brokers will do it as
well if you request it.
Jack Guttentag 2004