A few weeks ago, I answered a question from a reader who was applying for a mortgage. This was the week when interest rates dropped a half a percent over night. The reader had locked in at the higher rate and was wondering what he should do now that the interest rates were so much less than what he had been offered.

I suggested that he go back to the mortgage broker and ask what his options were. While the borrower had “locked in” his rate, he hadn’t yet closed on the loan and could have walked away from it and gone somewhere else.

I also suggested that mortgage brokers might want to reach out to their borrowers to talk them through an interest rate change and to help keep them as customers, rather than taking a hands-off approach and allowing other companies offering more competitive rates to cherry-pick them.

This column ignited a firestorm of commentary from mortgage brokers nationwide, but particularly those who read this column in the Oregonian. The gist of the commentary (which can be read in full here http://blog.oregonlive.com/myoregon/2009/01/mortgages_rate_locks_and_ethic.html) is that borrowers who pay to lock their loans (typically there is a fee for the application and the lock) exhibit unethical (although legal) behavior in breaking the locks.

(There were also some unkind comments about how my making “unethical” suggestions is in part responsible for the current housing market malaise and the general state of “entitlement” that Americans seem to have. Lots of real estate industry professionals seem to feel that journalists in general are in some way responsible for the housing crisis because we report negative news all the time. My response: If there were positive housing news, as there was for so many years, we’d report that.)

Some of the mortgage brokers who contacted me or responded in commentary online have made some good points: Breaking a locked loan, as rightly pointed out by Steve Emory, a senior loan officer with Pacific Residential Mortgage, based in Lake Oswego, Ore., causes problems for mortgage brokers who are required to close a high percentage of locked loans to the lender. Part of the reason is that there are some costs to the investor for pushing the paperwork of the loan.

If too many people break the locks, the end lender (or investor) “punishes” the mortgage broker by cutting off access to its funds. So instead of having 20, 50 or even 300 potential investors for a particular mortgage, the mortgage broker would have access to fewer and possibly be less competitive in the marketplace.

More competition is better, from a consumer perspective, because it should push down rates. With 300 investors to choose from, the mortgage broker should be able to find you the best rate available given your income, debts, home equity, etc.

Fannie Mae, Freddie Mac Buy Mortgage Loans

That’s not really how the market is functioning at the moment, since the federal government (through Fannie Mae, Freddie Mac and FHA) is purchasing the vast majority of loans. Also, although the federal government has been working to bring down the overall interest rates on 30-year fixed-rate loans, banks and other lenders have increased the spread (which pays their overhead and profit) between the interest rate they pay versus the interest rate they wind up charging home buyers and homeowners looking to refinance. Bottom line: rates and fees are all over the place.

As for ethics, it goes both ways. My mail shows that there are more than a few unethical mortgage brokers and bankers out there who are doing whatever they can to profit from the current confusion in the marketplace, as well as from home buyers and owners who are suffering from the worst real estate market since the Great Depression.

I have shared some of these emails with you: The woman whose mortgage broker wanted to charge her $26,000 in closing costs on a $250,000 FHA loan; the loan officer who suggested that a reader refinance her loan although her monthly cost would go up and her loan term would stay the same (he told her that “she would pay less in interest” with the new loan, with the loan officer pocketing $4,500 in fees); mortgage lenders who wrongly tell borrowers that they can’t qualify for Grade A loans, and put them in a loan meant for a borrower with much worse credit. And then there are those who pushed pay-option ARMs.

The FBI reports that mortgage fraud has gone through the roof, and there’s a borrower on the end of every one of these bad loans. I have no way to quantify this, but I’d like to think there are many more honest mortgage lenders out there than the crooks or bad business people who are putting their interests first and home buyers’ and homeowners’ interests last. But this column is supposed to give consumers a hand in making smarter moves when it comes to buying, selling, fixing up and refinancing their homes, and so I mostly write from the consumer perspective.

What I was trying to suggest to mortgage brokers out there is a way to be a better business partner in tough times. But the mortgage brokers are right that borrowers must understand that locking in a loan has wide-ranging repercussions throughout the financial system. It isn’t just the mortgage broker you’re dealing with. It’s the broker’s lender and perhaps another investor beyond that one, plus others who touch your loan.

In a future column, I will attempt to remove the curtain and explain exactly what happens between the time someone locks a loan and closes on it.

Ethics Versus Legality of Breaking Loan Locks

But for now, borrowers can legally break a loan lock and cross the street to get a lower interest rate. While that may not be “ethical” in a mortgage broker’s world, it is legal and it may happen more frequently as consumers understand more about their options and how to search for better loans on better terms.

How do some mortgage brokers solve the lock-breaking problem these days? Some mortgage lenders require that borrowers pay a substantial sum at the time they lock the loan, cash which is effectively a down payment on closing costs. That’s cash a borrower would then lose if he or she fails to close on the deal.

Some mortgage brokers have promised borrowers in the past that they could close on the deal and just simply refinance shortly in order to achieve the lower interest rate. (This is also a big no-no in the investor world, and if it happens too many times, can result in a mortgage broker being locked out by a particular investor). In some cases mortgage brokers promise the borrowers that they would pay no closing costs or fees the next time they refinanced.

I think more transparency would be helpful in an industry in crisis. I think mortgage brokers should also recognize that if a homeowner can save an extra $50 per month by breaking a lock and crossing the street, there’s a good chance he or she may do it.

To stop that, mortgage brokers, like all small and big businesses in a fast-changing world, may need to adapt some of their businesses practices to consumers needs. As our new president said earlier this week, the word of the age is “change.”

Jan. 19, 2009.