But My Rate Was Locked, Wasn't It?
This morning we got a question over on the “Ask Zillow” side that reminded me again that the jargon in the lender world is imperfectly understood by the general borrowing public.
No, strike that. My English teacher would be appalled (right, Mrs. Russell?). Here’s what I meant to say: It reminded me that most people haven’t a clue what loan people are talking about most of the time.
The question was, “When is my rate locked?” One of the answers was “is this a rhetorical question? It’s locked when it’s locked.” I am not making this up. Obviously, that answer is true, yet monumentally unhelpful. When we reach a point where the lenders and the borrowers don’t even understand what the other party doesn’t understand, then we’re in trouble. So in an attempt to bridge the gap, I offer the following.
A rate lock is a commitment by a lender to the party taking out the loan. This can be on the part of the servicing lender to the funding lender (secondary-to-primary) or on the part of the broker to the borrower, or a number of other possible combinations. Confused yet? Sorry. It’s actually simpler than it sounds.
Here’s an analogy: I have a big vat of lemonade. You want to buy some lemonade from me so you can set up a lemonade stand. You come to me and say that you want 10 gallons of lemonade, and ask me how much it will cost. I tell you it will cost $1 a gallon. You want that lemonade, but you don’t want to pay for it right now, so you order the lemonade for delivery in 30 days. I agree to this. You have now locked the price of this lemonade, and I have set aside for you the 10 gallons you want. This represents the secondary mortgage market, when your broker locks a loan with his investors.
Now you go and build your stand. You engage salesmen to hawk your lemonade to the thirsty. You hire ten guys and send them out. They sell the lemonade for you. They come back and say, “I can sell a gallon of lemonade for delivery 30 days from now. How much will that cost me?” You consult your accountant, and decide that you can sell that lemonade for $1.50 a gallon. The salesman takes that information, and makes the sale to the public. When he gets an order, he goes back to you and tells you to reserve a gallon of lemonade for delivery in 30 days. This is a rate lock between the borrower and the broker.
What is immediately obvious is that there are two different locks here. One is out in front, what most people call “locking their rate”, which is the second example. When a borrower locks his rate, he believes that he is going to get the loan at the rate he locked. What he rarely understands is that the rate has a time limit on it, and is subject to the honor of the loan officer he locked with. A million things can make the closing take longer than the lock period. Go over that time limit, and the rate changes. A million things can prevent the loan officer from getting a borrower’s lock transmitted to the guy that owns the vat of money. Fail to get that lock down with the investor, and the rate could get very expensive for the loan officer.
The other is the back-end lock, between the secondary market investor and the broker. That contract is fairly inviolate, but has zero flexibility. If your broker locks with an investor, the lock will be honored. But there’s no way to extend it for nothing – the investor will demand to be paid for any extension.
So what does all this mean? If you’re a borrower, keep these things in mind:
- Your loan is not locked until you are explicitly told it is. Do not assume that your rate is locked just because you got a Good Faith Estimate.
- Your rate lock is not guaranteed. Your broker may or may not honor the commitment he gave you. Likely he will, but if he does not, you’re not going to have recourse.
- Once you lock, the clock is ticking. You cannot afford to dawdle. You need to take it upon yourself to provide everything you’re asked for as fast as you can.
- Your broker has certain flexibility. If it’s definitely his fault the loan took too long, he can often be induced to pay for the extension. Also, if rates drop while your loan is locked, he may be able to slide your rate down. Mortgage shoppers should remember, however, that that rate lock has provided them protection against rate increases, and that rate protection has cost their broker something. You might consider being loyal to a person that has stuck his neck out for you, even if someone else comes along that seems to have a better deal.
If you’re a broker or a loan officer, here are some things to remember:
- If a client tells you he wants to lock, do not make a commitment to him until you have one yourself. It sounds easy to take one phone call and make another one right away, but you and I both know that what sounds easy often isn’t. Never promise what you cannot be sure you can deliver.
- Do not roll the dice. It is tempting to take a lock from a borrower, then roll the dice, holding off locking with your investor and betting that pricing will get better and you’ll make more money. Don’t do this. The stress of watching the market isn’t worth the few bucks you’ll occasionally make. And if you blow it – you know what I mean here – you’re going to get killed in reputation and in dollars. It’s not worth it.
- Stand by what you say. If you tell a client his loan is locked, honor that lock, whatever it costs you.
Hope this sheds some light on one of the obscure-but-critical terms we use in the mortgage industry. Next time, we’ll tackle the term “securitized mortgage derivatives”. Wait. On second thought…