If market price changes, lock should be based on ‘twin sibling rule’
A price quote means nothing until it is properly locked with the lender. A rate lock, as it is commonly called, is the lender’s commitment that it will make the specified loan at the specified price within a specified future period.
The price includes not only the interest rate but also points, which are upfront charges expressed as a percent of the loan; fixed-dollar charges; and (if the loan is adjustable-rate) the margin and maximum rate.
Locking has become more difficult: Before the financial crisis, if you started early enough in the day, it was relatively easy to contact a lender and lock the price the same day. Today, it is extremely difficult, if not impossible.
Delays are more frequent today than before the financial crisis, and the delay periods are longer. Before the crisis, income and asset documentation as well as appraisal requirements were often waived, facilitating the locking process. There are few, if any, waivers today.
Determining the property value, which has a major bearing on the terms of a loan, is particularly problematic. Before the crisis, lenders would lock based on the borrower’s or broker’s estimate of value if it was a refinance, or based on the sale price if it was a purchase, confident that in the great majority of cases the appraisal would confirm the value. Appraisals in buoyant markets generally did.
Today, lenders cannot have this confidence because appraisals have become conservative, and they also take longer. So lenders do one of two things: Either they require an appraisal before they lock, or they lock without it but require that the appraisal, when it materializes, show a value above some level for the lock to remain valid.
Lock delays carry risk to borrowers: Because market prices are highly volatile, lenders reset them every morning, and often during the day as well. This makes it very likely that the price on the lock day will not be the same as the price quoted to the borrower earlier, on which the borrower’s decision to proceed was based. While prices may change in either direction, the risks to the borrower are not symmetrical. Borrowers waiting to lock will always pay more if the price has risen, but they won’t necessarily pay less if the price has declined.
Lock scamming is all too easy: A lender who locks at the current price when that price is higher than the one quoted to the borrower earlier should do the same when the current price is lower. However, few borrowers are likely to object if they are locked at the price they were quoted previously, and my soundings suggest that this is a common occurrence. The irony is that the borrowers who consider themselves victimized are the ones who pay a higher price following an increase in the market price, whereas the real victims are those who pay the same price following a market decline.
The good faith estimate (GFE) doesn’t help: The GFE is a federally required disclosure of rates, fees and other loan characteristics that must be provided to the borrower within three business days of the submission of a loan application. It is designed to protect borrowers against a variety of hazards, but it does not protect them against lock scamming.
If the loan has been locked at the time the GFE is issued, any scamming has already occurred. If the loan is not locked when the GFE is issued, the rates and fees shown on the GFE are pre-lock quotes similar to those quoted to the borrower orally, but many borrowers don’t understand this. The GFE states that "the interest rate for this GFE is available through [date]," and if the loan has not been locked, the lender enters a day that has already expired. This is a horribly roundabout and confusing way to tell the borrower that the loan is not locked.
Protecting yourself against lock scamming: When the market price changes between the time the lender quotes a price to the borrower and the time the loan is locked, the lock price should be based on the "twin sibling rule": That rule states that the price locked will be the price the lender would quote on the same day on the identical transaction to the borrower’s twin requesting a price quote. If the new market price is below the price quoted to the borrower earlier, the lender will lock the lower price. If the new market price is higher than the price quoted earlier, the lender should not lock until explicitly authorized to do so by the borrower.
How does a borrower verify that the lender has followed this rule? One way is to monitor market changes on a day-to-day basis. The best tool for this purpose is my daily series on wholesale mortgage prices.
Even better is to deal with lenders who provide access to their pricing systems through third-party multi-lender websites, where borrowers can check their price on the system when they lock. Three sites that provide this facility are mortgagemarvel.com, zillow.com and mtgprofessor.com, which is mine.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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