What Is a Best Efforts Mortgage Lock?
A best efforts mortgage lock happens when the sale of a mortgage in the secondary mortgage market requires that the seller—usually a mortgage originator—makes their best effort to deliver the mortgage to the buyer.
A mortgage originator can be either an institution or an individual that works with a borrower to complete a mortgage transaction. A mortgage originator is the original mortgage lender and can be either 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. With this kind of lock, if the mortgage fails to close, then the cost of this will be borne by the secondary buyer of the mortgage and not the original mortgage lender.
Best efforts mortgage locks can be compared with a mandatory mortgage lock, in which the seller of a mortgage must either deliver the product to the buyers by a specific date or incur a fee, called a pair-off fee.
- A best efforts mortgage lock is a type of sale of a mortgage into the secondary mortgage market.
- With a best efforts mortgage lock, the seller—usually a mortgage originator—makes their best effort to deliver the mortgage to the buyer.
- Best efforts mortgage locks exist to transfer the risk that a loan will not close from the originator to the secondary market.
How a Best Efforts Mortgage Lock Works
A best efforts mortgage lock is a type of sale of a mortgage into the secondary mortgage market. The secondary mortgage market, where mortgage locks take place, is the market where mortgage loans and servicing rights are bought and sold among mortgage originators, mortgage aggregators, and investors.
The secondary mortgage’s extremely large and liquid 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, including pension funds, insurance companies, and hedge funds.
When a person 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, they then 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.
Mortgage locks—which include both best efforts mortgage locks and mandatory mortgage locks—determine the penalty that must be paid if a mortgage is not paid back to the buyer. Essentially, a best efforts mortgage lock means that the mortgage originator—in our example here, a bank—must make a reasonable effort to pay back the mortgage to the buyer—in our example here, an aggregator such as Fannie Mae. However, no fee is due if the seller fails to meet this payment.
Mandatory Mortgage Lock vs. Best Efforts Mortgage Lock
Another kind of mortgage sale on the secondary market is the mandatory mortgage lock. With a mandatory mortgage lock, the seller of the mortgage is required to make the delivery to the buyer by a certain date or pair-off out of the trade.
A mandatory mortgage lock or trade generally commands a higher price in the secondary mortgage market than best efforts locks because fewer hedge costs are associated with mandatory mortgage locks. Because the buyer can be (almost) certain that the loan amount will be repaid, they need not take measures to mitigate the risk of default.
Benefits and Risks of Best Efforts Mortgage Locks
Several types of organizations buy mortgage debt on the secondary market, including institutional investors, pension funds, insurance companies, and hedge funds. For these buyers, best efforts mortgage locks and mandatory mortgage locks represent different levels of risk.
Mortgage originators that 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.
A mandatory mortgage lock carries more risk for the mortgage seller than the best efforts mortgage lock. Also, whereas the mandatory mortgage lock requires that the mortgage be delivered or paired-off out of the trade, the best efforts mortgage lock does not. In practice, this means that with a best efforts mortgage lock, the risk is carried by the buyer, whereas a mandatory mortgage lock carries risk for the seller.
Best efforts mortgage locks shift risk away from the seller of mortgages on the secondary market, and mortgages with this kind of lock are therefore less costly for buyers because they assume more risk.
What Is a Best Efforts Mortgage Lock?
A best efforts mortgage lock is a type of sale of a mortgage into the secondary mortgage market. Under a best efforts commitment, the originator agrees to make a genuine attempt to deliver a particular loan with a specified note rate, term, and dollar amount within a certain period of time.
How Does a Best Efforts Mortgage Lock Work?
Best efforts commitments are made on a loan-by-loan basis. One loan cannot be substituted for another. If the borrower closes on the loan, then the originator typically must deliver that loan to the secondary market buyer. However, if the loan doesn’t close for any reason—for example, if the borrower doesn’t qualify or backs out of the loan—then the investor simply cancels the lock-in without any financial penalty.
How Does a Best Efforts Mortgage Lock Differ From a Mandatory Mortgage Lock?
Mandatory mortgage locks carry a higher risk because if the seller fails to come through with the mortgage, they must pay a fee, whereas there is no pair-off fee for the seller who fails to deliver the best efforts mortgage.