Mandatory Mortgage Lock

What Is a Mandatory Mortgage Lock?

A mandatory mortgage lock is the sale of a mortgage in the secondary mortgage market with terms that require the seller of the mortgage to make the delivery to the buyer by a certain date or incur a pair-off fee. The requirement to make delivery of the mortgage or incur a pair-off fee makes a mandatory mortgage lock different from a best efforts mortgage lock, in which the seller is not at risk of having to pay a pair-off fee. A mandatory mortgage lock also carries more risk for the seller of the mortgage.

A pair-off fee is charged if the loan fails to close. The investor typically charges the pair-off fee based on current market prices, so as to fairly compensate the investor.

Understanding a Mandatory Mortgage Lock

A mandatory mortgage lock or trade generally commands a higher price in the secondary mortgage market than best efforts locks because there are fewer hedge costs associated with mandatory mortgage locks.

The secondary mortgage market, where mortgage locks take place, is the market where mortgage loans and servicing rights are bought and sold between mortgage originators, mortgage aggregators, and investors. The large and liquid secondary mortgage market helps make credit equally available to all borrowers across geographical locations. Mortgage originators sell a large percentage of their new mortgages into the secondary market, where they are packaged into mortgage-backed securities and sold to investors, such as pension funds, insurance companies, and hedge funds.

When a borrower takes out a home loan, the loan is underwritten, funded, and serviced by a bank. Because the bank has used its own funds to make the loan, it can sell the loan into the secondary market to make more money available to continue issuing loans. The loan is often sold to large aggregators, such as Fannie Mae. The aggregator then distributes thousands of similar loans in a mortgage-backed security.

The Best Efforts Mortgage Lock

Another kind of mortgage lock for sale in the secondary market is the best efforts mortgage lock, which requires the seller, usually a mortgage originator, to make a best-effort attempt to deliver the mortgage to the buyer. A mortgage originator can be either an institution or an individual who works with a borrower to complete a mortgage transaction.

A mortgage originator is the original mortgage lender and can be a mortgage broker or a mortgage banker. Best efforts mortgage locks exist to transfer the risk that a loan will not close from the originator to the secondary market.

Mortgage originators who hedge their own mortgage pipelines and assume fallout risk usually sell their mortgages into the secondary mortgage market through mandatory mortgage locks or assignment of trade transactions. Because mandatory mortgage locks and assignment of trade transactions do not transfer hedge risks to the buyer, they generally command better pricing on the secondary market than best efforts mortgage locks.