Did You Pay For Insurance You Didn't Get?

Revised July 10, 2000

"How can I be sure my mortgage broker is reputable? I thought I had locked myself into a good rate for 45 days…but the company is dragging its feet…Every time I ask a question they seem to be bothered and the deal appears to become more and more tentative…They won’t give me a closing date…Should I be seeking another broker?"

Maybe, maybe not. Mortgage brokers today are struggling with the massive amounts of paperwork associated with the refinancing boom, when the level of service provided by mortgage brokers and lenders alike deteriorates. More than likely that is the only reason for the delay in your case.

On the other hand, you may have fallen into the hands of a sharpster. Since refinance booms create attractive opportunities to make a lot of money in a short period, they invariably attract new players prepared to use questionable business practices to make a quick score. These characters are a distinct minority but they cast a pall over the entire industry.

To protect yourself, it is important to understand the difference between the way the lock system works with a reputable mortgage broker, and the way the system is abused by the sharpsters.

Lenders who operate through mortgage brokers quote prices that vary with the length of the lock period – the period for which the quoted prices are guaranteed regardless of what happens in the market. With a "float", in contrast, the terms that apply are those prevailing at the time the loan is closed. For example, on a 30-year fixed-rate mortgage at 6.5% interest the lender might offer the prices below, to which the broker would add a markup, say 1.5 points, as follows:

Commitment Lender's Prices Broker's Prices
Float 0 Points 1.5 Points
30-day Lock 0.5 Points 2.0 Points
60-day Lock 1.0 Points 2.5 Points

If you request a 60-day lock, the broker will quote you 2.5 points, of which 1 point would go to the lender and 1.5 points would be retained by the broker. The reputable broker will then inform the lender that a 60-day commitment has been made to you, and the lender will acknowledge this in writing. This acknowledgement is your protection against the possibility that interest rates rise within the 60 days. In effect, the lender has sold you an insurance policy against that contingency, and the 1 point difference in price between the 60-day lock and a float is the insurance premium.

The sharpster, however, while quoting you the 60-day lock price, will not lock the loan with the lender. If interest rates don’t change during the 60 days, the broker will deliver the loan to the lender at the float price – pocketing 2.5 points instead of 1.5 points. One point was your insurance premium, which the broker did not buy. If interest rates go down, the broker will make even more.

But suppose rates go up and the new float price quoted by the lender is 3 points? The broker cannot now deliver on the promise of a loan to you at 2.5 points without paying the difference out of his own pocket. Most brokers will take the small hit, which is how they rationalize the practice. However, they leave the borrower exposed to a major interest rate spike, which they cannot cover. This is more fully explained in Should Mortgage Brokers Play the Market? When interest rates jump and the refinance boom ends, the quick-score artists disappear, leaving a slew of victimized consumers behind.

How do you protect yourself? Referrals are good to have, but not from recent borrowers. Since sharpsters deliver loans so long as interest rates remain favorable, recent experience with them means nothing. Seek referrals from before 1994, because they mean that the mortgage broker was in business before the current refinance boom. Referrals from real estate sales agents are useful because sales agents don’t usually deal with fly-by-nights. Mortgage brokers affiliated with reputable real estate companies are safe, and so are reputable mortgage banking firms and depository institutions.

Since you are already involved with a mortgage broker, and evidently you did not do your homework beforehand, I suggest the following. Tell your broker that you want to see the rate lock commitment letter from the lender identifying you as the applicant. Many mortgage broker will be reluctant to show the commitment letter because it reveals the lender’s price, and thereby discloses the mortgage broker’s markup. But they will do it rather than lose the deal, provided there is a commitment letter. If no letter exists, they will give you every explanation they can think of why they can’t show it to you. That’s the cue for you to bail out.

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