To Lock or Not to Lock–That is the Question!
One of the proverbial questions that mortgage professionals hear from their clients and prospects is “when should I lock?” Another variation of this same question is “when are rates going to fall?” So many times, this question is loaded and the mortgage banker, broker, or loan officer is painted into a corner and unsure of the answer to be credible. Indeed, my favorite question is “if I lock now and rates fall, can I get the lower rate?” This is a real song and dance question that I really hate as some lenders let you “float down and others don’t.” The unfortunate thing about this line of questioning is that a blow of the wind can literally spoil the reputation of a mortgage professional, because the science behind locking a rate is out of their hands.
Where rubber meets the road, locking a rate involves the investment of money and the allocation of capital. Mortgages are just like any other financial instrument (e.g. CDs, mutual funds, stocks, and bonds) in that they provide a return on investment. In many cases, the interest rate on a borrower’s promissory note represents a substantial portion of someone else’s retirement fund. The mortgage industry is huge, and has grown into a money making machine with an established infrastructure which originates, services, sells, and pays off billions of dollars of mortgage loans per day. Across the United States as people lock loans, “secondary” departments across the mortgage spectrum are working full speed to prepare pools of mortgages for sale. As loans of similar characteristics are placed in a mortgage pool to be sliced and diced for the investing publics purview, the secondary departments are trying their best to plan a pipeline. However, so much of pipeline planning is not in their control either. The hunger on “the Street” may be for 3.375% 15-year mortgages or 4.00% 30-year mortgage product, but if the market is “out of sync” it may not happen. As we have seen in 2012, a market rally can drive rates upward and kill a mortgage pool waiting to be filled, as a 15-year mortgage product may increase from 3.375% to 3.75% in the blink of an eye with a jobs report.
Additionally, there could be a stall in the pipeline due to an over abundance of product. You can have too much of a good thing in real estate finance. If a particular lender is getting too much volume for a particular product (high balance Fannies at 4.25%), they will intentionally slow down their pipeline by raising their own rates beyond what the market has justified to something like 4.625%. I can think of more than a few instances where a particular lender will purposefully raise the rate on a mortgage product beyond what the market will bear because their returns on the product are so low to the point when they sell them off to the secondary market there is very little margin for any profit. Accordingly, if economic forces are driving 30-year mortgages down to 3.875%, but one lender chooses to peg their rate at 4.375%, the difference in rate could be explained by that particular lender’s over abundance of product on the books or a very thin profit margin on that product.
Furthermore, Japanese tsunamis, European flu, domestic hurricanes, victory of the socialist party in France or the defeat of an austere fiscal conservative in Greece can send interest rates into uncontrollable gyrations. Each one of these preceding instances is not hypothetical. As we all know, each has occurred in our recent history, and had a noticeable effect on interest rates. Accordingly, when factors such as these which drive the market occur, there is no static strategy for locking rates. Therefore, each mortgage professional will follow their own course of action based on their gut and/or professional experience.
Many believe that if the rate is comparatively low, they should lock it for 45-60 days and not worry about it. To them, it is better not to tempt fate as the market could change overnight (for the worse). Others are of the opinion that if the general feel of the market is that rates will stay low a borrower shouldn’t lock until the very end of the loan process. These individuals believe that there is always some piece of data that can push rates lower by waiting. By and large, blips can send rates in the opposite direction. For instance, Apple was seen as running out of steam and out of fresh ideas to continue its torrid pace of growth after Steve Jobs death. Then its earnings came out and they were the best ever. They sold more iPhones and iPads than ever before. The market jumped and so did rates–at a time when the rest of economy was in the doldrums. Since the earnings announcement, rates had remained high until the resurgence of the European flu. So, it doesn’t always pay to play the wait and see game, especially if you are dealing with any type of deadline. Personally, I base my rate lock strategy on a person-by-person philosophy. If you are working with a conservative borrower, lock for the longest viable period needed to close escrow. Conversely, if you are dealing with a Vegas-pro, chances are they will want to let it ride. However, I always advocate disclosing risks and uncontrollable circumstances in writing.
In summary, determining when to lock your interest rate is a decision faced by tens of thousands of borrowers everyday. If you lock too soon, you may miss out on further rate reductions. If you wait too late, a market shift could put your refinance on the shelf. Each borrower needs to decide their risk tolerance for watching and locking a rate in the same way they determine their risk tolerance for investments. A windstorm, parliament, jobs report, or sales of an Apple product can make one’s dream rate seem so far away. It’s a perilous decision to make, so choose wisely.
Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance, he can be reached at firstname.lastname@example.org.