Mortgage Rate Locks

Cache Landing · Sep 19, 2006

Let's say that the current 30-year mortgage rate is 6.0% but I'm not sure that I'll be able to close within the next month. So I lock-in the rate for 60 days.

Is anyone familiar enough with the lending institutions to tell me how they hedge against an increase in long term rates during the next 60 days? Even more so, how would they hedge a 120-day locked rate?

Rates could go up a whole 1% during the next few months. In those cases, do the banks just eat the loss and give me the lower rate, or do they hedge using the bond index, or something else?

Cache Landing · Sep 19, 2006

Also, is the mortgage rate more closely tied to the 10-year treasury or the 30-year? I can't find any charts to compare it with the 30-year, but the TNX seems to have a very high correlation. It seems that for the most part 0.10 (average 30 year mortgage) = 1.00 (TNX)

Anyone that know something about this would be greatly appreciated.

Smart Money · Sep 19, 2006

Quote from Cache Landing:

Also, is the mortgage rate more closely tied to the 10-year treasury or the 30-year? I can't find any charts to compare it with the 30-year, but the TNX seems to have a very high correlation. It seems that for the most part 0.10 (average 30 year mortgage) = 1.00 (TNX)

Anyone that know something about this would be greatly appreciated.

I find there is good correlation with the 10-year treasury. Its also easier for me to track. FWIW, rates have dipped a good bit in the last month or so.

QuoteBoy · Sep 20, 2006

the 10yr. is the better choice.

I though rate locks had the added benefit of giving you a lower rate if rates went down...??? I also thought the trade was already paid for in form of a higher cost cost mortgage than say a 30 day rate lock.

Cache Landing · Sep 20, 2006

Quote from QuoteBoy:

the 10yr. is the better choice.

I though rate locks had the added benefit of giving you a lower rate if rates went down...??? I also thought the trade was already paid for in form of a higher cost cost mortgage than say a 30 day rate lock.

Some of them don't lock you into the higher rate.

You're right, the instituions generally require a non-refundable deposit to lock in the rate. My question has to do with what they then do to hedge against something like a 1% jump in rates.

For easy numbers let's say that I was going to buy a house for $100,000 and the rates were currently 6%. The deposit required of me for a rate lock would be fairly low (like $500-600) but if rates went up 1% during the next two months, that would be about a $24,000 loss in profits for the lending institution.

Do they use my deposit somehow to hedge against that risk, or is it purely an odds bet that the rates won't go up?

drmarkan · Sep 20, 2006

Quote from Cache Landing:

Some of them don't lock you into the higher rate.

You're right, the instituions generally require a non-refundable deposit to lock in the rate. My question has to do with what they then do to hedge against something like a 1% jump in rates.

For easy numbers let's say that I was going to buy a house for $100,000 and the rates were currently 6%. The deposit required of me for a rate lock would be fairly low (like $500-600) but if rates went up 1% during the next two months, that would be about a $24,000 loss in profits for the lending institution.

Do they use my deposit somehow to hedge against that risk, or is it purely an odds bet that the rates won't go up?

Basically the only thing they do is finance more loans at the new rate. The rates although determined by the LIBOR, are also tied to the 10 year note. If the 10 year rate is up, you are going to have a higher rate because the brokers commission (or rebate) is determined by the rate they give you. In other words, let's say that the broker is going to offer you 6% as your rate. If the 10 year is at 4.75%, the broker is making 1 point in rebate. Rebate is paid by the lender to the broker. If the 10 year is at 5%, the broker is making half a point. This is why if you are fairly savy and have an honest broker, you should watch where the 10 year is at to determine if you are getting a good rate.

Most likely the broker is going to want to make a point in rebate to make the loan worth their time, so in the above case, if the 10 year were at 5%, you are going to get to lock in at 6.25% instead of 6%. Or the broker will charge you points out of your pocket to make up the difference.

There really is nothing to hedge, because the paper that is held evens itself out anyways. There are still investors holding the paper regardless. In theory, the lender is getting stiffed if there is a one percent increase in say two months, but that type of move would be extremely unprecedented. The extra cost you pay to lock in for a longer period is more for your protection than theirs.

Cache Landing · Sep 20, 2006

Quote from drmarkan:

Basically the only thing they do is finance more loans at the new rate. The rates although determined by the LIBOR, are also tied to the 10 year note. If the 10 year rate is up, you are going to have a higher rate because the brokers commission (or rebate) is determined by the rate they give you. In other words, let's say that the broker is going to offer you 6% as your rate. If the 10 year is at 4.75%, the broker is making 1 point in rebate. Rebate is paid by the lender to the broker. If the 10 year is at 5%, the broker is making half a point. This is why if you are fairly savy and have an honest broker, you should watch where the 10 year is at to determine if you are getting a good rate.

Most likely the broker is going to want to make a point in rebate to make the loan worth their time, so in the above case, if the 10 year were at 5%, you are going to get to lock in at 6.25% instead of 6%. Or the broker will charge you points out of your pocket to make up the difference.

There really is nothing to hedge, because the paper that is held evens itself out anyways. There are still investors holding the paper regardless. In theory, the lender is getting stiffed if there is a one percent increase in say two months, but that type of move would be extremely unprecedented. The extra cost you pay to lock in for a longer period is more for your protection than theirs.

Thanks, I figured I would eventually find someone who at least knows something about it.

So basically, just another avenue for them to make some additional coin for their pockets.

drmarkan · Sep 20, 2006

Quote from Cache Landing:

Thanks, I figured I would eventually find someone who at least knows something about it.

So basically, just another avenue for them to make some additional coin for their pockets.

Basically. If you are financing a home, don't automatically assume you need a 60 day lock if that is how long your escrow period is going to be. If you feel that rates will remain stable, then wait until you are 30 days out in order to avoid shilling out some extra cash. Most likely if you have a good broker, he will float the lock anyways.

uptik2000 · Sep 20, 2006

120 day locks are rare unless it's a construction loan.
if your mortgage company is charging you to lock a 30 or 60 day rate you should find another company.

You also have different types of lenders.

-mortgage brokers: they don't fund or service your loan. they simply hook the customer up with a lender and take a fee for it.

-direct lender who fund but don't service your loan: they fund it at closing but already have it sold to a lender in the secondary market. They also receive a "service release premium" (SRP) for this. A change in interest rates has no effect on them

-lenders who service a portfolio of notes: these are the biggies like Citimortgage, Wells Fargo, National City etc. Massive size. Packaged, hedged, MBS traders, servicing...you name it, they do it.

I hope that helps.
If anyone on this board has any questions about a mortgage or you want me to look at a deal that some mortgage company is selling you...feel free to PM me . I can take a look at the GFE(good faith est.) for you.
I'm not in that biz anymore but I know the tricks brokers try to use to pull more $ out of you.

QuoteBoy · Sep 20, 2006

Quote from Cache Landing:

Some of them don't lock you into the higher rate.

You're right, the instituions generally require a non-refundable deposit to lock in the rate. My question has to do with what they then do to hedge against something like a 1% jump in rates.

For easy numbers let's say that I was going to buy a house for $100,000 and the rates were currently 6%. The deposit required of me for a rate lock would be fairly low (like $500-600) but if rates went up 1% during the next two months, that would be about a $24,000 loss in profits for the lending institution.

Do they use my deposit somehow to hedge against that risk, or is it purely an odds bet that the rates won't go up?

more on this. theres actually lots more on this! I don't hedge for a bank, but it goes something like this: there a lot of things the banks can do. the question is do they want to hold it, or sell your loan. If Sale - then they sell into the mortgage TBA market or securitize it for monthend or next month settle. the TBAs trade 30,60,and 90 day fwd. In your case they, in theory, would agree to give you the loan then immediately short it into the 60day TBA and once you've originated, they turn around and deliver your loan. the forward drop between 30 and 60 and 90 day would be a few ticks each. The $500 represents the difference in the market value of a mtge your size for sale in the 30 vs. 60 day fwd mkt. the problem of the 1% drop in rates is today's holder of the 60 TBA for example a mutualfund, but its not the bank's problem.

If they choose to hold it, it goes into the bank's mortgage portfolio and they hedge accordingly. at this point they're not specifically hedging your loan for 60 days etc...