What is a Mortgage Rate Lock Float Down?
A mortgage rate lock float down refers to a mortgage rate lock that gives the borrower the option to reduce the interest rate on their mortgage if the market interest rates fall during a specified period. It provides the borrower with security that their mortgage rate will not increase, and that they can also take advantage of lower mortgage rates should they arise.
A mortgage rate lock float down will usually coincide with the closing date of a property – a borrower must take advantage of it before or on the closing date.
Mortgage Rate Lock Float Down Structure
Traditionally, a mortgage borrower either takes a fixed-rate mortgage or a variable-rate mortgage, but neither of the products offers the advantages of a mortgage rate lock float down. Fixed-rate mortgages lock in a rate for the entire term of a mortgage, while a variable-rate mortgage allows the mortgage rate to fluctuate with the prime lending rate of the institution.
A mortgage rate lock float down allows a borrower to take advantage of declining mortgage rates, but it does not expose them to higher mortgage rates if they arise.
Here are the basic mechanics behind a mortgage rate lock float down:
1. The lender provides a baseline for how much rates must fall
Lenders will usually offer a mortgage rate lock float down if mortgage rates are 0.25-0.5% better than the locked rate. For example, if you’re offered an interest rate of 4.25%, and your lender requires a 0.5% difference for a float down, then the current rates would need to fall to 3.75% for an individual to take advantage of the option.
2. Integrated renegotiation fee
Some lenders will charge a loan percentage amount for the float down option. For example, a lender may charge an individual 1% on a $500,000 loan to exercise the float down option. If the individual opts to exercise the float down option, they would need to pay an additional $5,000 (1% of $500,000) to the lending institution.
3. No change to mortgage lock expiration date
A borrower is required to either exercise or void the float down option before closing. Many lenders make it explicitly clear that they are not able to extend the lock period for the float down, even if your closing date is extended.
4. You must ask the lender for a float down
The float down option is not automatically executed. A borrower must request the option be exercised, whether in person, over the phone, or through email.
5. Prior conditional loan approval may be required
Some lenders require that a borrower received approval on a previous loan to acquire the float down option. Also, a lender will usually reserve the right to review a borrower’s credit, income, and assets before assigning the float down option.
Advantages of a Mortgage Rate Lock Float Down
Some advantages of a mortgage rate lock float down include:
1. Advantages of falling rates
A float down option provides the opportunity for a borrower to effectively low their mortgage costs if rates fall.
2. Protection from rising rates
If mortgage rates rise, a mortgage rate lock float down will provide downside protection to the borrower.
Limitations of a Mortgage Rate Lock Float Down
Some limitations of a mortgage rate lock float down include:
1. Payment is required even if it is unused
The borrower will still be required to pay any fees associated with the float down option, even if they do not end up exercising it.
2. Speculative in nature
Many float down options are included in mortgage terms by borrowers who believe the underlying mortgage rate will fall. If mortgage rates show a consistent history of falling, a borrower may inadvertently enter a float down option with the belief that mortgage rates will continue to fall.
An individual wants to purchase a home. They’ve already made an offer on their dream home. To acquire the property, the individual is required to acquire a mortgage before the closing date. They choose to integrate a mortgage rate lock float down option in their mortgage to take advantage of recent falling mortgage rates.
Below are the terms of the borrower’s mortgage agreement:
- Locked rate of 4.5% for 30 years.
- The borrower must pay a fixed $1,000 fee to exercise the float down option.
- The float down rate is set at 4.25%.
If, before closing, the mortgage rate falls to or below 4.25%, the individual will have the option to lock in the new lower rate. It may not sound like a large difference, but if the loan amount is $5,000,000, then it makes a huge difference:
- $5,000,000 at 4.5% means an individual would need to pay $9,120,334 over the life of the loan.
- $5,000,000 at 4.25% means an individual would need to pay $8,854,920 over the life of the loan.
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