What Is a Float-Down?
October 30, 2001, Revised July 10, 2002
"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 sometimes called a "float-down". A float-down provides the same upside protection as a lock, plus an option to reduce the rate if market rates decline. Like a 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. 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.
But a float-down comes at a price. For example, a price sheet I recently looked at 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.
"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 current market price is determined and communicated to you.
The last point is worth stressing. I would not pay for a float-down where the market 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.
"I read your article about the distinction between a lock and a float-down, and why a float-down is more expensive. But 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?"
If you allow a lock to expire, waiting for rates to go down, the lender providing it will not lock another loan for you for some period -- often 60 days. If rates decline near the end of the lock period and there isn't time to close, the lender will probably be willing to extend the lock period, but at the original price, not the improved price. So if you play the waiting game, you may be forced to go to another loan provider.
That inconvenience aside, your logic is sound. Your morals, however, are shaky: you committed yourself to the terms in the lock and by allowing it to expire so you could get a better rate, you are reneging on that commitment.
On a lock, both and the lender and the borrower promise that the loan terms agreed upon will be honored when the loan closes, regardless of what happens to market interest rates in the meantime. The lender is bound by the lock if interest rates go up, and the borrower is bound if they go down.
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 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.
Lock-jumpers raise the cost of locks to lenders, who pass on the cost to other borrowers who don’t play. 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.
A case can be made that lenders should offer only float-downs on refinance transactions because that’s what refinancing borrowers really want. Conventional locks result in under-pricing to lock-jumpers and over-pricing to everyone else.
"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 sometimes called a "float-down". A float-down provides the same upside protection as a lock, plus an option to reduce the rate if market rates decline. Like a 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. 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.
But a float-down comes at a price. For example, a price sheet I recently looked at 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.
"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 current market price is determined and communicated to you.
The last point is worth stressing. I would not pay for a float-down where the market 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.
"I read your article about the distinction between a lock and a float-down, and why a float-down is more expensive. But 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?"
If you allow a lock to expire, waiting for rates to go down, the lender providing it will not lock another loan for you for some period -- often 60 days. If rates decline near the end of the lock period and there isn't time to close, the lender will probably be willing to extend the lock period, but at the original price, not the improved price. So if you play the waiting game, you may be forced to go to another loan provider.
That inconvenience aside, your logic is sound. Your morals, however, are shaky: you committed yourself to the terms in the lock and by allowing it to expire so you could get a better rate, you are reneging on that commitment.
On a lock, both and the lender and the borrower promise that the loan terms agreed upon will be honored when the loan closes, regardless of what happens to market interest rates in the meantime. The lender is bound by the lock if interest rates go up, and the borrower is bound if they go down.
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 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.
Lock-jumpers raise the cost of locks to lenders, who pass on the cost to other borrowers who don’t play. 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.
A case can be made that lenders should offer only float-downs on refinance transactions because that’s what refinancing borrowers really want. Conventional locks result in under-pricing to lock-jumpers and over-pricing to everyone else.