Is It A Great Time To Float The Market?
Is this a great time for a home buyer to float the market? In my opinion, no. In times of significant market uncertainty and price volatility, like we have now in the markets, locking is usually the better option than floating. In hindsight, floating this market had more losers than winners from September 17 to present.
Here are my top reasons why I believe locking is a better than floating when markets are volatile and uncertain, which is clearly the present state of the bond markets and could be so for several months:
1. You have more to lose than to win. Each day there is a 50/50 probability that the next day’s MBS prices could be better or worse than today’s. On most days, a floating borrower is making a 50/50 bet that the next day’s price is better. On boring, normal market days a floating borrower will win half of the time.
However, if something unexpected catastrophic happens in the world tomorrow that is very bad for bond prices, a floating borrower will now have a much higher rate which in some cases may cause them to no longer qualify for the loan, and regardless they are now stuck having a higher monthly mortgage payment for possibly a very long time, possibly forever. A floating borrower has no protection from a catastrophic market event occurring.
If something unexpected happens in the world tomorrow that is very good for bond prices, and this causes mortgage rates to go much lower, a floating borrower wins, but a locking borrower can get to the same rate in a few months by doing a refinance.
A floating borrower will win 50% of the time and lose 50% of the time if no big market moves happen. If a big market move happens for the worse, a floating borrower will be paying a higher interest rate, possibly for a very long time and possibly forever,
A locking borrower will also win 50% of the time if there are no big market moves, but if a big market move happens for the worse, they are completely protected and if one happens for the better they can refinance to the lower rate in a few months.
In summary, a floating borrower bears the full risk of anything catastrophic happening in the world that could be very bad to mortgage rates, but their “win” is to save themselves having to refinance if rates drop. A locking borrower completely protects themselves from the risk of anything bad happening in the world, and they are only delayed a few months from refinancing to a lower rate.
Which downside would you rather face? Locking and your worst-case scenario is rates drop and so you pay a higher rate than you could have for the next six months until you refinance? Or you are floating and your worst-case scenario is you are paying a higher rate for the rest of your life?
2. There is no such thing as “carefully floating” the market. No expert anywhere can predict tomorrow’s pricing being better or worse beyond a 50/50 win/lose rate. Many events that have significant impacts to market prices occur prior to the market’s daily opening, meaning a borrower who thinks they are carefully floating will not have any chance to lock yesterday’s rate once the next day’s much worse rate sheet comes out.
3. Locking is a heads you win, tails you win bet. A borrower who locks completely protects themselves from rates getting worse and they can still benefit if rates get better by refinancing at some point in the future. They are protected from a potential large loss for a long time period as a tradeoff for not having a small gain for a short time period.
4. Locking is a good strategy in times of market volatility and uncertainty. The United States is the only country in the world where a person can lock their interest rate before they close their loan and then buy a home with a 30-year fixed rate that can never go up but allows them to refinance to a lower rate at any time without any penalty. By locking their loan, the borrower completely protects themselves from rates going higher, and they can still fully benefit if rates go lower by doing a refinance. In my opinion this is the safest strategy and will produce the best economic results for a homebuyer.
