“I locked my 30-year fixed-rate mortgage at 5.5 percent and 1 point, but at closing I was dunned for $2,800 in lender fees of various types that had never appeared on the Good Faith Estimate. Why didn’t the lock protect me against that?”

A lock is designed to protect borrowers against a rise in price between the lock date and closing, but the protection is often inadequate or fails altogether. You just discovered (the hard way) one of the reasons.

In locks covering fixed-rate mortgages (FRMs), most lenders include only the interest rate and points. (Points are an upfront charge expressed as a percentage of the loan amount.) They leave their fixed-dollar fees out of the lock. Then, if the market goes against them–for example, say they have to close a 5.5 percent mortgage in a 6 percent market–they can cover at least some of their loss by jacking up their fees.

Based on past experience, the paragraph above is going to elicit angry denials of the “we are a reputable firm and would never stoop to such practices” variety. OK, if you would never stoop to such practices, it will cost you nothing to include fixed-dollar fees in your locks.

Truth in Lending, administered by the Federal Reserve, requires that lenders must display the APR whenever they display an interest rate. The APR measures cost to the borrower and includes the rate, points and fixed-dollar fees. All the Fed needs to do to eliminate fixed-dollar fee abuses is to require that when lenders lock a rate, they also lock the associated APR. Since the APR includes these fees, locking the APR is the same as locking the fees.

When it comes to adjustable rate mortgages (ARMs), the issue of lock coverage becomes even more complex, as illustrated by the next letter.

“My ARM has been locked for about 53 days. Yesterday the lender wrote and said the loan has changed from a 2/2/5 to a 5/2/5, though the rate remains locked until settlement next week. I have two previous e-mails from the lender confirming the 2/2/5 caps. Aren’t the caps locked with the rate?”

They should be, but obviously in this case they were not. You have a legitimate beef and I would protest loudly and strongly.

Most ARMs have two kinds of rate caps. Adjustment caps limit the size of any rate change, and lifetime caps set a maximum rate over the life of the mortgage. ARMs on which the initial rate holds for three years or longer, have two adjustment caps: one applies to the first rate adjustment and the other applies to all subsequent adjustments. A 2/2/5 means that the initial adjustment cap is 2 percent, the subsequent adjustment cap is also 2 percent, and the lifetime cap is 5 percent above the initial rate. 

If they shift you to a 5/2/5, the initial adjustment cap would be 5 percent rather than 2 percent. That will cost you a bundle if market rates are substantially higher when the first rate adjustment comes around.

The general practice in locking ARMs is to lock the initial rate, points, the margin (the amount added to the rate index on a rate adjustment), and the maximum rate. These are viewed as components of the “price” of the ARM, which can vary from borrower to borrower. As with FRMs, fixed-dollar fees are not included.

Rate adjustment caps are not included in a lock because they are considered to be part of the definition of the particular ARM program, along with the term, rate index, initial rate period, subsequent rate adjustment period, and sometimes other features. These do not change from case to case, or from day to day, so there is no reason to include them in a lock.

Changing the first adjustment cap on you could mean that the loan officer mistakenly thought the cap was 2 percent when it actually was 5 percent. Mistakes happen, but the lender should eat a mistake made by an employee, not you. Alternatively, after you locked, the lender might have decided to change the program definition by raising the first adjustment cap to 5 percent. He is entitled to do that but he is not entitled to apply the new program definition to you because you locked the previous version of the program.

This episode suggests that it is prudent for a borrower locking an ARM to have a written description of all the features of the ARM, whether they are part of the price or not. Such a list is provided on my Web site, see “Information Needed to Evaluate an ARM.”

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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