Higher Rates

The Processing Capacity Problem

The boom stretched to the limit the capacity of lenders to process loans. Reluctant to add more employees when the boom could fizzle out at any time, lenders preferred to lengthen the processing period and let borrowers queue up for longer periods. But purchasers often have closing dates they must meet, and lenders strive to give them priority over refinancers. Pricing refinance a little higher is one way to do this because it cuts the number of refinancers in the queue.

The Lock Risk Problem

Another factor was at work as well. It costs lenders more to lock the interest rate on refinance loans than on purchase loans. Usually, this is not important enough to cause a difference in pricing, but that also changed during the refinance boom. When lenders lock, they assure the applicant that the rate will hold if market rates increase after the lock. Lenders lose if market rates are higher when they close, and they gain if market rates are lower. If loan applicants who lock always went to closing, over time, lenders would gain as much from rate declines as they lost from rate increases. But in practice borrowers do not always close, and the fall-out as it is called is larger when rates are falling. Some applicants are "lock-jumpers". They lock, and if rates subsequently decline, they find another loan provider and lock again at a lower rate. Locking thus imposes a net cost on lenders.

This cost is larger on refinancings than on purchases because lock-jumping is more common among refinancers. Borrowers who are refinancing usually are flexible on when they close. Most purchasers, in contrast, must close on a specific date and don’t have time to restart the process with another lender. The prolonged refinance boom increased the number of refinancing lock-jumpers. An unusually large number of borrowers refinanced multiple times within just a few years, learning the ropes in the process. One thing they learned is how to lock-jump. This widened the difference in lock cost to lenders between refinancings and purchase loans. Lenders and brokers were partly to blame for this because they only rarely put applicants on notice that they are committed by a lock. They fear that such a warning in itself could send the applicant running to another loan provider. But the result was to raise the cost to all those who refinance.