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No Such Thing as 'Free' Rate Lock

June 28, 1998|JACK M. GUTTENTAG | SPECIAL TO THE TIMES

QUESTION: A lender offered me a "free" 60-day rate lock. What exactly does that mean? I am always suspicious of anything that is offered free.

ANSWER: 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 will increase during that period.

On home purchase transactions, the lock-in period ranges generally from 15 to 90 days. In cases when a home is being built, however, it may be longer, and on refinance transactions it may be shorter.

If the loan is not closed within the stipulated period, the protection expires and you have to either 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 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 start the process over again with a new lender to get a lower rate.

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 need protection for only 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.

Jack M. Guttentag is a syndicated housing finance columnist and is professor of finance emeritus at the Wharton School of the University of Pennsylvania.

Questions can be e-mailed to jack@ghrmars.com.

Distributed by Inman News Features.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Average Mortgage Rates and Indexes

Weekly Survey of 90 Southland Lenders as of June 18, 1998

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Latest One Week Six Months week previous previous Rates for loans under $227,150 30-year fixed 6.66%/1.98pt 6.66%/1.95pt 6.90%/1.98pt 30-year ARM start rate 5.64%/1.61pt 5.65%/1.65pt 5.78%/1.61pt 15-year fixed 6.50%/1.69pt 6.46%/1.78pt 6.64%/1.89pt Rates for loans over $227,150 30-year fixed 6.99%/1.93pt 6.95%/1.99pt 7.22%/2.04pt 30-year ARM start rate 5.72%/1.38pt 5.73%/1.44pt 5.77%/1.62pt 15-year fixed 6.76%/1.71pt 6.72%/1.69pt 6.97%/1.91pt FHA or VA mortgage average points 7.00%/1.18pt 7.00%/1.21pt 7.00%/1.98pt CALVET 30-year ARM start rate 6.95% 6.95% 8.00% 6-month LIBOR 5.742% 5.718% 5.906% 1-year treasury bill 5.400% 5.420% 5.490% 6-month treasury bill 5.120% 5.140% 5.210% 6-month certificate of deposit 5.630% 5.650% 5.800% Prime rate 8.500% 8.500% 8.500% 11th District cost of funds 4.903 4.917 4.957 For the month of April '98 March '98 Oct. '97

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Compiled by Mortgage News Co., Morro Bay, Calif.

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