What Is a Float-Down?

October 30, 2001, Revised July 10, 2002, January 22, 2011

"I heard an ad by a lender on the radio this morning that said, in effect, that if I borrow from them I don't have to worry about rate increases because they would lock the rate, yet if interest rates go down they will reduce the rate. How can they do this, or is it some sort of scam?"

No, it isn't a scam, it is what is called a "float-down".

Float-Downs Compared to Rate Locks

A float-down provides the same upside protection as a rate lock, plus an option to reduce the rate if market rates decline. Like a rate lock, a float-down is an option that can be attached to any kind of mortgage. Since it carries more value to the borrower than a lock, however, and is more costly to the lender to provide, the borrower pays more for it.

On a lock, the lender promises that the loan terms agreed upon will be honored when the loan closes, regardless of what happens to market interest rates in the meantime. In principle, the borrower is bound by the lock if interest rates go down, and the lender is bound if they go up. Borrowers, however, sometimes walk away when rates go down, provided they have enough time and the inclination to start the process over again with another lender. To prevent this, some lenders charge a non-refundable fee that borrowers lose when they walk, but many do not.

With a float-down borrowers have the right to have the rate reduced. They need not walk out on their obligations, relinquish any fees they have paid, and start the loan search all over again. Usually the right can be exercised only once, at which point the float-down converts to a lock.

Float-Downs Come at a Price

On a float-down, the lender is committed to the terms agreed upon if interest rates go up before closing, but if rates go down the borrower has the right to lock again at a lower rate. Since this imposes an additional cost on the lender, the price of a float-down is higher than the price of a lock.

A price sheet I looked at (in 2002) showed that on a 30-year fixed-rate mortgage at 8.5%, the lender charged 1.625 points to lock the rate for 120 days. (A point is 1% of the loan amount). The comparable price for a float-down was 2.625 points. The borrower was thus paying 1 point for the right to take advantage of any reduction in market rates that occurred within the 120 day period.

Terms of a Float-Down

"I have a rate lock with a float down, and rates have gone down since the lock. However, my mortgage broker says that he can't float down until the week of the close, and only if the rate is more than 1/4% lower. Is that right?"

Probably. Float-down terms are set by each lender who offers them -- there is no standard contract.

Of course, the broker should have explained the exact terms of the float-down going in. These include when you can exercise, any minimum decline in rate or points, and how the floated-down price is determined and communicated to you.

The last point is worth stressing. I would not pay for a float-down where the floated-down price is communicated to you over the telephone. You should get a copy of the price sheet with the relevant price circled at the time you lock, and then again when you get to the exercise period. That's how you know you are getting what you paid for.

Allowing a Rate Lock to Expire Instead of Paying For a Float-Down: "Lock-Jumping"

"... it seems to me that if I’m refinancing, there isn’t any point in paying for a float-down, because if interest rates go down, I can just let the lock expire and lock again. Is there something wrong with my logic?"

A borrower who accepts a lock but allows it to expire when interest rates go down so he can lock again is in effect getting a float-down at the lock price. I call them "lock-jumpers". While lock-jumping is difficult to do on a purchase transaction where the borrower has a closing date that must be observed, on a refinance, it is easy – much too easy. The only cost is the inconvenience of having to go to another lender, since the lender providing the lock will not lock another loan for you for some period -- often 60 days.

The Cost of Lock-Jumping

Lock-jumpers raise the cost of locks to lenders, who pass on the cost to other borrowers who don’t play. The result is under-pricing to lock-jumpers and over-pricing to everyone else. In this regard, lock-jumping is like shop-lifting. And just as merchants have an obligation to make it difficult to shop-lift, lenders have an obligation to make it difficult to lock-jump.

Obvious ways to discourage lock-jumping are to charge a non-refundable fee for a lock, or offer only float-downs on refinance transactions. The problem is that the lenders who adopt such policies place themselves at a competitive disadvantage.

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