(This is Part 7 of a seven-part series. See Part 1: Mortgage shopping: what you should know before you begin; Part 2: Pros and cons of fixed, adjustable mortgages; Part 3: Three options available on most mortgages; Part 4: How long should you take to pay off your mortgage? Part 5: Investment returns influence real estate down payment; and Part 6: Understanding choices in mortgage insurance.)
This is the last of seven articles on the decisions mortgage borrowers should make prior to entering the market. Previous articles were about selecting the type of mortgage, term, various options, down payment, and mortgage insurance. This article is about selecting the lock period and the documentation.
Lenders lock (meaning “guarantee”) the rate and points for a specified period. If a fixed-rate mortgage (FRM) is locked at 5.5 percent and one point for 45 days, for example, the lender is committed to closing at that price anytime within the following 45 days. For 30- or 60-day locks, expect to pay about one-eighth of a point less or more.
Lock expiration: If the loan has not closed by the end of the lock period, it expires, and the lender is no longer committed. If prices have not increased during the period, the lender will usually be willing to extend the lock for a small additional fee. If prices have increased, however, any lock extension will be at the new higher prices. You want to avoid this risk.
How long of a lock period do you need? On a home purchase, select a period long enough to include the expected closing date. On a refinance, ask the broker or lender how much time is needed to process the loan. In both cases, add 15 days just to be sure.
When should you lock? If you barely qualify at today’s rates, lock as soon as possible. You are in no position to risk an increase in rates.
If you are comfortable with the risk, you can delay the lock in order to take advantage of the decline in price as the lock period shortens. For example, if market rates don’t change, a 45-day price of 5.5 percent at one point 15 days later should become a 30-day price of 5.5 percent at seven-eighths of a point.
This assumes, however, that you receive an honest reading of the market price on the day you lock. You will if you are dealing with an Internet lender who posts your price on the Internet every day. You are also safe if you are dealing with an Upfront Mortgage Broker (UMB) who gives you the best wholesale price on the lock day. In other cases, you may or may not get an accurate reading. The loan provider who knows you are in too deep to back out may up the price a bit, so the one-eighth point will go in his pocket rather than in yours. With no independent check, the “market price” is what the loan provider says it is.
On a purchase transaction, the cost of failure to close is usually high. If you can’t completely trust the loan provider, you should lock while there is still time to find a new one.
On a refinance, a delay in closing is usually less costly, and those refinancing with new lenders have an additional option: they can rescind the deal within three business days after closing. In practice, this won’t protect against an avaricious loan provider unless the borrower makes clear that he knows how the game is played and is prepared to exercise his options if necessary.
Documentation Requirements: These stipulate that, a) the information about income, assets and employment that must be provided by the borrower, b) whether and how the lender will use this information, and c) whether and the lender will verify how the information provided.
What Documentation Requirements Should I Seek? Lenders usually offer multiple choices, from the most demanding called “full documentation,” to the least demanding called “no-docs.” In-between is “stated income,” where the borrower has sufficient income to qualify but cannot fully document it, “no-ratio,” where the borrower’s income does not meet the lender’s standards but the borrower considers it adequate, and others.
Because the risk to the lender rises as documentation requirements become less stringent, the price of the mortgage rises correspondingly. In general, therefore, borrowers receive better pricing the more documentation they provide, though providing documentation can be a hassle. Some borrowers have such a strong aversion to the hassle that they are willing to pay a price to avoid it.
That’s OK so long as the decision is yours and not the loan provider’s. Occasionally they steer a borrower into less demanding documentation in order to make less work for themselves. That, you don’t permit.
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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