A floatdown is an option or feature that allows a borrower to “lock in” a lower interest rate after they have already committed to a mortgage rate, should interest rates drop before their mortgage is finalized. This option provides some flexibility for borrowers who want to protect themselves from rising rates (by locking in) but also benefit from a potential rate drop (by “floating down”).
How float downs are used
Floatdowns are used in several ways, but the most common are during negotiations, before closing or while getting pre-approved for a mortgage.
Before Closing
A borrower agrees to a fixed or variable rate when securing their mortgage. If interest rates fall before the closing date, they can exercise the float-down option to adjust to the lower rate.
Pre-Approval Application
Typically, in Pre-Approval or Rate Lock Agreements, borrowers might lock in a rate when they apply for a mortgage, but some lenders allow them to float down to a lower rate if one becomes available before the mortgage is finalized or funded.
During Negotiations
Sometimes, float-downs are included as part of the mortgage agreement from the start, but it may come with a fee or certain conditions. The borrower needs to inquire if the lender offers this option and under what circumstances.
Why Floatdowns Are Used
Mortgage rates are tied to the bond market of the prime rate set by the Bank of Canada. As such, they are exposed to a degree of volatility. Given there can be period of months between when a borrower goes looking for a mortgage, makes a successful offer to purchase or sell real estate, and the time it takes for the deal to close, a lot can happen to rates in the interim.
Protect Against Rate Volatility
Mortgage rates can fluctuate between the time a borrower gets approved for a mortgage and when the deal closes. A float-down helps ensure that the borrower doesn’t miss out on a potentially better rate.
Risk Management
Being able to ‘floatdown’ a mortgage gives borrowers peace of mind knowing they won’t be stuck paying a higher interest rate if rates fall during the period between mortgage application and closing.
Competitive Edge
Lenders might offer the floatdown feature to attract customers who are concerned about fluctuating rates but are not sure when to finalize their decision.
How to Calculate a Floatdown
The mechanics of a float-down are straightforward. If the borrower locked in at, say, 5% interest and the rates drop to 4.75% before closing, they could request to “float down” to the lower rate. However, float-downs usually have the following conditions:
- Timing Window
- One-time Use
- Fee
- Rate Adjustment
- Eligibility
Timing Window
The float-down option typically only applies within a certain time frame, like 30 to 90 days before closing.
One-Time Use
Borrowers can often only use the float-down option once. If rates drop again after using the float-down, they may not be able to adjust further.
For example, one lender has the following floatdown policy,” One rate float down is permitted per submission. It must be requested in writing no later than 7 business days prior to the closing date (9 calendar days). No exceptions. In rare cases float downs may not be permitted on promotional rates.”
Another lender states, “If you have a commitment for one of our 45 day promo rates and your rate is now higher than our regular 90 day rates, we will allow a ONE time floatdown on the rate. As with our 90-120 rates we do allow a one-time floatdown.”
Fee
Some lenders charge a fee for this service, which could be a flat fee or a small percentage of the loan amount. This cost may affect whether it is beneficial for the borrower to exercise the option.
Rate Adjustment Cap
Some lenders may limit how much the rate can drop under the float-down. For example, even if the market rate drops by 1%, the borrower may only be allowed to reduce their rate by 0.25% to 0.5%.
Eligibility
Not all lenders or mortgage products offer float-down options. Borrowers need to check with their mortgage agent or lender to confirm if and how it is available.
Summary
A floatdown option is a useful tool for borrowers looking to secure a better rate if market conditions improve, and it can help mitigate the risk of rate fluctuations between mortgage approval and closing. However, it often comes with limitations and potential fees.
