Rate Lock Agreements: Timing is Key

By Brad Dashoff, Special Counsel, Real Estate, Land Use & Environmental Practice, Sheppard Mullin: Location is often described as the key to a successful real estate transaction. While generally true, timing also plays an important role, especially when entering into an interest rate lock agreement as part of a financing transaction.

Dashoff Brad 11-12

Location is often described as the key to a successful real estate transaction.  While generally true, timing also plays an important role, especially when entering into an interest rate lock agreement as part of a financing transaction.  Locking an interest rate usually occurs when negotiation of the loan documents is concluding and the parties are ready to close.  However, at this point, the borrower has lost most of its leverage to request any changes to the rate lock agreement.  The lender knows it is unlikely that the borrower will walk away from the transaction because of a disagreement over the terms in the rate lock agreement.

In addition to losing leverage, borrowers should also be conscious of market factors.  As has recently occurred, interest rates can sometimes spike up quickly, which, depending on the magnitude, and the size of the loan, may make it impractical to close a loan that was otherwise about to close.  Requesting a copy of the rate lock agreement early on in the transaction and proposing modifications as soon as possible affords the borrower the opportunity to better understand the terms in the rate lock agreement in the event rising interest rates cause the borrower to want to quickly lock an interest rate, as well as providing time to negotiate provisions that are often not negotiated due to time constraints on locking a favorable rate.  A few types of provisions that, given time, can be negotiated, but often are not, are:

Rate Lock Deposit and Costs and Expenses

Since the deposit is ultimately applied against the borrower’s closing costs (assuming there is a closing) and is not a profit center for the lender, lenders are often willing to accommodate requests to waive or reduce the deposit for shorter-term rate locks.  If a borrower asks for a waiver or reduction of costs and expenses early enough in a transaction, the lender may be flexible in the timing and scope of the amounts that ultimately become the borrower’s responsibility.  For example, a lender may agree that the borrower will only be responsible for paying these amounts if the loan either fails to close or fails to close within a specific number of days.  These might seem like small victories for the borrower, but not having to come out-of-pocket in advance of closing or having additional funds at risk in the event that closing does not occur are appreciable benefits that are often not requested because of time constraints in locking the rate.

Rate Lock Extension Periods and Costs

Asking up front for the ability to extend the rate lock period will remove some of the lender’s leverage to require the borrower to choose to either close on loan terms that are not completely satisfactory to the borrower or risk losing the locked rate.  Extension of the rate lock period will typically require payment of an extension amount and the borrower should make sure that any such payment will be credited against the borrower’s costs at closing and not be an additional fee for the lender.

Lender’s Right to Terminate

Borrowers should try to limit the lender’s ability to terminate the rate lock agreement for anything other than a material, monetary default by the borrower. Some agreements will allow the lender to terminate if the lender determines that a material adverse change in the economy or market has occurred.  This type of provision gives the lender a fair amount of latitude to terminate the agreement and should be rejected by borrowers.  While there will be less risk of termination the closer to closing the rate lock occurs, there is still some risk, even if the rate is locked only overnight, that the lender can terminate the rate lock agreement and force the borrower to either walk away from a near-closed loan or close the loan at a presumably higher rate than the rate previously locked.  Also, if interest rates are increasing and the borrower wants to lock a rate earlier than it otherwise intended, the material adverse change provision may allow the lender to terminate, leaving the borrower in the same position as if it had not locked the rate in the first place.

Requesting the rate lock agreement early in a financing transaction will help keep the borrower in the best position to both negotiate certain provisions more favorably and to lock a rate earlier than expected, if desired, with reduced additional cost.