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Understanding How Mortgage Rate Locks Work

Borrowers sometimes lose locked rates even when shouldn't

March 15, 2018

By JACK GUTTENTAG The Mortgage Professor (Tribune News Service)



A rate lock is a commitment by a mortgage lender to lend a stated amount to a specified borrower posting a specified property as collateral, at a stipulated interest rate and points.

An important proviso is that the loan must be closed within a specified "lock period," which is usually 15 to 60 days. The lock protects the applicant against the possibility of a rise in market rates during the lock period that could make the mortgage unaffordable.

With interest rates inching upward, questions about the reliability of locks will arise with increasing frequency in the months ahead.


Property Appraisals as a Lock Disrupter
The price of a mortgage usually varies with the ratio of loan amount to property value. Since the price is often locked before the property has been appraised, the value used will be the sale price if it is a purchase transaction, or the owner's estimate of value if it is a refinance.

If the appraisal then comes in at an amount that is materially lower or higher than the value used in setting the lock price, it may invalidate the lock. This recent letter illustrates the problem.

"I am refinancing my mortgage and locked at 4 percent with $1,700 in total closing costs. But the appraisal came in at $411,000 instead of the $422,000 I had estimated, on the basis of which the rate was raised to 4.125 percent. Is this justified, or am I being taken advantage of?"

On the face of it, the answer to this borrower's question was not obvious. The lower appraisal raised the ratio of loan amount to property value, which gave the lender an excuse for raising the rate. A closer look, however, reveals that the rationale was spurious because the low appraisal did not move the transaction into a new price category.

The initial price based on an 88 percent ratio, and the new price based on a 90 percent ratio should have been the same because both fell in the 85.1 to 90.0 pricing category that is universally used in the marketplace.

While the borrower in this case was certainly taken advantage of, more borrowers are exploited by appraisals that come in higher than the previous estimate. If the appraisal in the example had come in at $436,000 instead of $422,000, the loan-to-value ratio would have been 84.8, dropping it into the 80.1 to 85.0 pricing category, which should result in a lower price. Had this happened, the lender could have cheated by doing nothing, which is a temptation that is very hard to resist. To avoid this possibility, consumers estimating property value should err on the high side.

Note that if borrowers rather than lenders ordered appraisals, they would do it before seeking a loan, so they would not have to guess the property value in shopping lenders or in negotiating a rate lock. The potential disruption caused by appraisals arriving late on the scene is just one of the costs of the dysfunctional practice of placing control of property appraisals with the lender rather than with the borrowers who pay for them.


Lock Expiration as a Disrupter
Probably the most important source of lock disruption is a failure to get the loan closed within the lock period. Such failure usually means that important information bearing on the acceptability of the property or the borrower was not received in time. Lenders will extend the lock without charge if they are responsible for the delay, but in most cases the applicant is held responsible and the lender's lock commitment expires. If the lock expires, any new lock will be at the prices prevailing at that time.

The applicant is presumed to be responsible for the failure to close on time because documenting the acceptability of the applicant's finances and property is the responsibility of the applicant. When the loan application and supporting documents emerge from the office of the underwriter who has examined them, it is either approved, which makes it ready to close, or it may be approved subject to the provision of additional documents. The list of required documents is provided to the applicant.

The lender might be responsible for failure to close on time by taking too long to process and underwrite the loan, or by failing to identify missing information in a timely matter so that the borrower can provide it within the lock period.

Needless to say, responsibility for failure to close can be a contentious issue.
Loan applicants with or without access to an ombudsman are advised to keep a log showing the date on which they provided each of the documents requested by the underwriter.


About the Writer
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.

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Copyright (c) 2017, The Mortgage Professor

Distributed by Tribune News Service.


This story was distributed by TNS - Tribune News Service
 
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