Rate locks still play central role in loans

Part 1 of two parts

There was a time not long ago when rate locks were not a part of the conventional loan package. Borrowers had to pay for a lock in addition to the loan origination fee.

When mortgage interest rates were into double digits, the offer of a paid-for rate guarantee made a lot of sense – especially if the borrower could qualify for a 30-year, fixed-rate loan at 12.5 percent but did not have the income to qualify for the same loan amount at 13 percent.

With home loan rates now heading up more than down, the importance of a loan lock carries more significance. If the adjustable rate mortgage you want will be moving from 5.75 percent to 6 percent next week, it’s reassuring that you can get today’s lower rate, for free, when the loan closes.

While the genesis of loan locks can really be traced to the high-flying rate days of the 1980s, the quasi-insurance instrument has traveled a variety of roads. It has been used as a recruiting tool for lenders, a safety net for builders who could not finish homes on time and a smokescreen for some consumers who only wanted the lock honored when rates went up, not down.

Initially, a rate lock was self-explanatory – the borrower had the opportunity to secure today’s rate for 30, 45 or 60 days down the road. It was an easy decision in a market that seemingly was always on the rise because the borrower had the lender’s pledge that the interest rate would be the one you locked (and often paid for) when you applied. For example, if you received an 8 percent, 30-day lock and closed on time, the rate would be 8 percent at closing.

The borrower always had the option of floating with the market, thereby gambling that the rate at closing would either be lower than the rate at application or not worth the price paid for the lock (often 0.5 percent of the loan amount). If rates rose dramatically, some unscrupulous lenders would drag their feet and prolong the closing so that the loan lock would expire. The agreement from the start was if the loan was not closed on time, and was not the fault of the lender, all bets were off. The unhappy borrower was then forced to take a higher rate in order to finance the home.

But lenders were not the only ones who failed to honor rate locks. In September 1991, when interest rates began to dip under 9 percent for the first time in four years, borrowers who locked in at higher rates suddenly were behaving like superstar athletes attempting to renegotiate their contracts at midseason. Borrowers who had yet to sign on the dotted line suddenly went seeking a better deal.

What consumers did not understand was that the lender actually had made a commitment to the secondary market when the initial lock was secured. Much like a stock or bond, the lender was telling the market that he had a loan committed at a specific price.

Joe Ebner, former vice president of residential lending for Washington Mutual Bank, was getting three to four calls a day from people who had locked and then wanted a lower rate. Ebner, now retired and a part-time crabber, first tried to determine if WaMu had handled the loan in a timely fashion. If so, WaMu and many other lenders allowed borrowers out of their loan lock, yet kept a portion of the origination fee. Borrowers were then free to seek a better loan rate. Depending on the deposit, it was often financially prudent to stay with the same lender.

It was a curious time in mortgage lending. There were nasty tales of bait-and-switch tactics by lenders. However, consumers knew that most banks would honor their locks if rates went up, yet borrowers still wanted the option of getting a lower rate if rates came down. The situation gave way to “downside protection,” with lenders giving consumers exactly what they wanted.

Now, the competition for loans is so intense that many lenders don’t even think about charging for 30-day locks. While lenders handle locks differently, some long-term lock programs have evolved into a no-cost ceiling where the lender guarantees the rate will be no higher than the agreed upon locked rate, yet possibly lower. And, with loan origination fees now at a minimum, lenders face hours of lost time when consumers decide to walk away from a deal.

There are no financial indicators in the near term that would lift home loan rates in a hurry. However, if you agree to a loan – either with a rate lock or a rate float – do your best to hold up your end of the deal.

Next week: Why rate locks are critical to reverse mortgages.

Tom Kelly’s book “The New Reverse Mortgage Formula” (John Wiley &Sons) is now available in local libraries, bookstores and on Amazon.com.