Question: We applied for a mortgage loan about a month ago, and were told that our rate was locked in at 5.875 plus one point. We are going to settlement a week from now, and our settlement attorney has been advised that the rate will be 6.125 percent, plus 1.25 points. Needless to say, we are very upset. Is there anything we can do, and can the lender be held to its loan commitment?

Answer: When interest rates are dropping -- or are steady (as they have been for some time), no one complains. The mortgage "lock-in" situation has not been a problem in the past few years, since interest rates have been low, and falling. However, in the past few months, in anticipation that the Federal Reserve Board will increase bank rates, mortgage interest rates have started to rise, and this is when potential borrowers start to have problems.

Mortgage lenders often complain that no one objects when rates are falling, but are constantly upset when rates are on the upswing.

Many of the leading economic indicators are suggesting that interest rates will continue to rise. Indeed it is widely speculated that by the end of this month, when the Federal Reserve Board's Open Market Committee meets, there will be a significant hike in these bank rates.

Many borrowers are now faced with the possibility that the interest rate they applied for -- and were supposedly locked into -- will no longer be available.

What is a "lock in" rate? Oversimplified, this means that you have a binding commitment from your mortgage lender that for a fixed period of time (usually 30 or 60 days from the time you make your loan application) you are going to obtain the rate that was locked in by the lender. The lock-in obviously only impacts potential borrowers when rates start to move up. It is my opinion that the primary cause of consumer concern stems from lenders' lack of communication with their borrowers.

The Federal Reserve Board has prepared a very helpful publication entitled "A Consumers Guide to Mortgage Lock-ins" (FRB 4-50,000-0892-C), which can be obtained from the Board of Governors of the Federal Reserve System, Washington, DC 20551.

The Federal Reserve's definition of a mortgage lock-in is worth quoting:

A lock-in, also called a rate-lock or rate commitment, is a lender's promise to hold a certain interest rate and a certain number of points for you, usually for a specified period of time, while your loan application is processed ... A lock-in that is given when you apply for a loan may be useful because it's likely to take your lender several weeks or longer to prepare, document, and evaluate your loan application. During that time, the cost of mortgages may change. But if your interest rate and points are locked-in, you should be protected against increases while your application is processed ... It is important to recognize that a lock-in is not the same as a loan commitment, although some loan commitments may contain a lock-in.

The Fed goes on to point out that there are many different kinds of lock-ins. Options include a locked-in interest rate and locked-in points, a locked-in interest rate with floating points, or a floating interest rate with floating points, where the lender gives the borrower the option to lock-in any time between the application and the actual settlement.

Unfortunately, consumers have often learned the hard way that too many lock-ins are only verbal commitments, which are not reduced to writing. It is important that you get a written document on the lender's letterhead and signed by an authorized loan officer, spelling out the terms and conditions of your lock-in commitment. If the lender refuses to give you a written statement, you should start looking for another lender. A verbal commitment may not stand up in court, and in any event you really do not have the time -- or the money -- to file suit against the lender.

If the lender refuses to confirm in writing the terms of your lock-in, and you find that you do not have time to switch to another lender, send that lender a letter, by certified mail, return receipt requested, outlining your understanding of the lock-in commitment. If the lender does not respond, this will at least be some evidence of the existence of the lock-in promise.

Although some mortgage lender attorneys disagree, it is my opinion that a lender who locks-in a rate and then is unable or unwilling to meet that deadline may be in breach of contract.

Let us look at the basic elements of any contract. To have a valid, binding contractual obligation, three elements are required:

First, there must be an offer. Here the lender has offered a "locked-in rate" to the borrower.

Second, there must be an acceptance of that offer. Again, the borrower -- by telling the lender that he or she will accept that locked-in rate -- has validly accepted the offer.

Lawyers may differ as to whether the lender makes an offer or merely permits the borrower to make an offer to the lender. Nevertheless, in my opinion there is an offer and an acceptance between the borrower and the lender when the loan application is made and the lender states that the rate is "locked-in."

The third vital element of a contract is consideration. Usually, consideration is in the form of money. The borrower has given the lender money for the appraisal, the credit report and often one or more of the points that will have to be paid at settlement.

Even if the borrower does not give money as consideration, the law books also define consideration as something of value other than dollars. In your case, if you refrain from looking for another lender and rely on the lender's representations, that also constitutes valid consideration so as to make a contract between the parties.

It should be pointed out that the offer and the acceptance need not be in writing. While we need a written document for the sale of real estate, in this case we are not dealing with real estate -- but rather the financing of that real estate -- and oral representations are binding. The problem, of course, is proving that the statements were made.

Thus, assuming that you obtained a written document confirming that your rate was locked in, it is my opinion that your lender is contractually bound to honor the locked-in rate which was initially promised to you. You have relied on the lower rate, went to that lender in good faith, and the commitment should be honored.

There is a Maryland Court of Appeals case which is directly on point. According to the Court:

The inducement of a guaranteed rate of interest … especially in a time of fluctuating interest rates, clearly is intended to entice the customer to deal with the offering bank, rather than with some other lender. Although the customer does not covenant that he will refrain from simultaneously making application with other lenders, we think the practicalities of the home loan market, and particularly the expense of each application, have the effect of at least temporarily taking the customer out of the market. As a greater number of loan applications may be expected to result in a greater number of loans, and thus, a greater profit, business advantage to the bank is real, even though every application will not lead to a profit.

Now that rates are going up, we have already begun to see lock-in problems. Lenders can avoid this situation by disclosing to the borrower in writing the terms of the lock-in commitment. And this disclosure must be in simple English, not legalese. Usually, these lock-ins run for only 30 or 60 days. The borrower should be advised of this time limitation. The lender then has an obligation to process the loan promptly, and I recommend that borrowers contact their lender on a weekly basis to make sure that the loan process is moving forward.

Different lenders offer different lock-in terms. That of course is the lender's business. As long as the borrower understands the terms and conditions under which the loan application is being processed, the lender can do no more.

But if a lender arbitrarily and capriciously cancels a lock-in rate, that is, in my opinion, a breach of contract, to which the borrower has legal recourse.

If you have a problem, you have several options:

• First, talk directly to your mortgage lender. Try to speak with a supervisor, but make sure that you have all of your documentation in place before you make the call.

• State and local agencies can assist. Some states have Offices of Consumer Affairs; other states have Banking commissions. As a last resort, you can complain to the attorney general in your jurisdiction.

• Federal agencies supervise many mortgage lenders. You can complain to the Federal Trade Commission or the Federal Reserve Board. If your lender is a national bank, you can also file a complaint with the Office of the Comptroller of the Currency.

The "mortgage lock-in" will become a real concern to many consumers in the months to come. Education, information and communication between borrower and lender is the real key to preventing these issues from becoming problems.

Published: June 28, 2004

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Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of Kass, Mitek & Kass, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts. Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.