Erin Palmer and Chris Bennett: Rate-Lock Negotiations Offer a Short-Term Response with Long-Term Consequences

Erin Palmer is Founder and CEO of Blue Phoenix. He has held a number of executive leadership roles over the past 25 years. He has served as an Executive Advisor through the Teraverde Alliance to banks and mortgage bankers in these specialties. He currently serves as a board member for the Michigan Mortgage Lenders Association.

Chris Bennett is principal of mortgage industry hedge advisory firm Vice Capital Markets. He can be reached at cbennett@vicecapitalmarkets.com.

Rising interest rates and increased competition have loan officers scrambling for ways to win deals in today’s market. One tactic that has grown in popularity with borrowers and loan officers is rate lock renegotiations. However, these come at a high cost to lenders, and with margins already being squeezed, what seems prudent from a customer acquisition standpoint may actually work against lenders’ best interests.

Why renegotiate?

From the borrower’s perspective, a rate lock renegotiation seems like a no-brainer, as it allows them to take advantage of market dips and obtain a lower rate than the one they locked. What consumer wouldn’t want that?

Loan officers also often see this as an attractive option for securing deals with borrowers that may be on the fence given where interest rates are now versus a year ago. Offering hesitant customers the “assurance” that they’ll get the lowest rate no matter what can be the factor that pushes those customers to lock.

Many large consumer retailers utilize a similar strategy. If an item a customer purchased drops within a specified window from the purchase date, the customer can receive a refund for the difference between what they paid for the item and its new, lower price. This is often viewed as a sound customer acquisition and retention strategy in the retail goods space, so it’s easy to see why loan officers might want to adopt this approach to achieve similar aims.

In fact, several large lenders have previously promoted rate lock renegotiation programs as part of their mass marketing strategy. These programs often generate a lot of buzz, especially amongst loan officers that have lost deals due to these programs. Thus, rate lock renegotiation programs are often viewed as a critical advantage for loan officers in tight purchase markets, allowing them to go “toe-to-toe” with larger market competitors.

What’s the harm?

Although rate lock renegotiations are a win-win for borrowers and loan officers, there is a significant downside for lenders in adopting this as their de facto policy. In short, rate lock renegotiations are neither cheap nor free. To properly manage this risk, a lender must use options, which can be incredibly expensive if leveraged incorrectly. Depending on the market, a lender might pay an extra 60 basis points not just on the loans that renegotiate or float down but on every single lock. For example, consider a pipeline that includes 500 locks with an average loan amount of $200,000 for a total of $100,000,000. It may cost as much as $600,000 to manage the risk regardless of whether none, some or even the entire population floats down. Given how tight margins are currently, few, if any, lenders can afford to increase their profit margins by 60 basis points simply to cover the cost of such a program.

While some lenders would gladly eat the cost of rate renegotiations to gain market share on competitors offering similar programs, that, too, may be a fool’s errand, as what’s being advertised isn’t necessarily what’s being offered. Borrowers will lock with that lender assuming they’re locking with that rate renegotiation offer in place. However, the rate for that program is often higher than the programs offered without the renegotiation component. Because borrowers don’t know the difference, they will opt to lock at the lower rate, not realizing that in doing so, they are foregoing the renegotiation option. That realization can leave a bitter taste in borrowers’ mouths when rates drop.

This also assumes that all borrowers are rate-sensitive, which isn’t necessarily the case. According to data from STRATMOR Group’s MortgageSAT® Borrower Satisfaction Program, only 3% of borrowers reported choosing their lender based on rates alone, and issues with the interest rate only accounted for 4% of all problems consumers reported with their chosen lender. Thus, lenders could be paying 100% insurance on a threat that has a minute probability of occurring. Applying this to the earlier example, let’s say 7% of those 500 locks, or 35 loans, requested a rate renegotiation, and the net margin on those loans was 50bps. In this instance, the lender would be paying $600,000 to protect $35,000 of net margin, which is clearly ill-advised.

Now what?

Ultimately, the best renegotiation policy states that once a loan locks, the rate will not be renegotiated. However, there may be one-off situations where renegotiation makes sense. One example may be a loan where rates have dropped materially and most of the cost to manufacture the loan has been incurred. In this instance, it may make sense to reduce the margin to at least cover the cost and earn less margin. Lenders will need to determine for themselves under what circumstances they will allow this to occur.

Lenders also need to have a clear and specific business reason for adopting such a policy. While some may view recruitment as one of those reasons, that argument simply does not hold water. In today’s tight operating environment, the lost revenue will always outweigh the benefits an organization might gain from attracting “superstar” loan officers. In this vein, lenders must ensure that the policy they choose to implement limits renegotiations to only those instances when it truly benefits the organization. Anything less simply institutes a rate reset policy and not a true renegotiation.

When making this decision, transparency must be king. It can be challenging to quantify how many deals are won or lost because of a lender’s rate renegotiation policy (or lack thereof). Before changing either direction, lenders need to look beyond anecdotal evidence to verify the impact a policy change could have on their organization.

Once a decision has been made, lenders must then be cognizant of the timing of their policy change to minimize the overall impact. The last thing lenders want is to implement a policy change and have a significant portion of their pipeline caught in limbo or leave loan officers in a lurch, either having promised something they now cannot deliver or unable to take advantage of the policy change. While it seems counterintuitive, these kinds of policy changes should be made during periods of relative rate stability and with the intent of being applied against future rate swings. After all, the time to fix a leaky roof isn’t in the middle of a storm.

Given the current rate environment, it is understandable that lenders and loan officers want to react swiftly to preserve market share and keep pipelines full by employing customer acquisition/retention strategies like rate lock renegotiations. However, short-term responses rarely lead to long-term success. For lenders playing the long game, resisting the urge to attract and retain business by any means necessary will ultimately prove to be the winning strategy.

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at msorohan@mba.org; or Michael Tucker, editorial manager, at mtucker@mba.org.)