Recently a prominent national lender began advertising that you could lock your interest rate to protect it, and then go shopping for a home. What happens if rates go down while you’re shopping? The lender will drop the rate!
There’s no disputing this is an attractive offer for consumers, but it isn’t new and it’s important to understand the costs. There is no free lunch.
How to Lock in a Mortgage Rate
First you need to understand that when you lock your interest rate you’ve always had options as to how long to lock it for. “Locking” your interest rate means that you select a specific interest rate at a specific cost (say, zero points) for a specific period of time.
One "point" = 1 percent of the loan amount
The lender commits that interest rate and cost to you. In exchange, you agree to accept that interest rate and cost, and to close within that time period. If rates go up after you lock, you’re in luck. If rates drop, your rate most likely won’t be adjusted (more on that to come).
The longer the lock period you want, the more you will pay based on market pricing on the day you lock. Lock periods tend to be offered in 15-day increments. The difference in the cost for different lock periods depends on the lender and market conditions. As an example, if the interest rate you want costs -0- points for a 15-day lock, it might cost 0.250 points for a 30-day lock on the same day.
Do you need longer than 30 days? A 45-day lock might cost you 0.500 points, then, and a 60-day lock might cost you 0.750 or more.
Most lenders offer locks no longer than 60 or 90 days, and all of them charge quite a bit more for the lock if you want to lock for more than 60 days.
The cost increase is not always a straight line, however. The longer the lock, the more risk the lender takes that the interest rate market will change dramatically; if so, they may be stuck making a loan at an interest rate that loses them money. Most lenders, therefore, offer locks no longer than 60 or 90 days, and all of them charge quite a bit more for the lock if you want to lock for more than 60 days.
Now let’s consider the offer of a 180-day lock. As you can imagine, a lender has to charge quite a premium to take on that risk, and they do. If you want to know how much, after they quote you the 180-day lock price at the interest rate you want, ask them what the price would be for a 15-day lock. That’s the premium.
So, you can lock the interest rate in for a very long time, but you pay for it — quite a lot, actually.
What is a Floating Interest Rate?
What makes the offer more attractive is the float-down option. If rates go up, you’re locked in so you’re still happy. If they go down, the lender will drop the interest rate. Why would they be so generous? Because the lender has learned that despite the commitment you’ve made to take the lock at the price it has promised, if interest rates are lower when you find your home, chances are you’ll simply switch to another lender anyway.
But if the lender has you approved and ready to go and offers to meet you halfway, chances are you’ll finish the purchase with that particular lender.
If rates go up, you’re locked in so you’re still happy. If they go down, the lender will drop the interest rate.
Note I said “halfway.” The lender will float down your interest rate to the current rate, but at the same cost as the extended lock would be on the date the lender floated it down; you will still pay that premium.
So, is it a good idea to take an extended lock? Yes, as long as you understand that you are paying a premium to shift the risk of the interest rate market to the lender, or are willing to switch lenders when you finally find a home. (Here is where a broker can be valuable, as he or she can simply switch lenders for you.)
Competition is Good for the Consumer
While this offer is not new, it was rare in recent years until the lender mentioned above rolled it out again. Volume in the mortgage industry is down this year, and lenders are trying to find ways to attract your business.
Naturally, other lenders are now stepping up, including the largest wholesale lender in the country. (Wholesale lenders offer their products through mortgage brokers.) Today you should be able to get an extended lock, therefore, through any mortgage broker.
Should I Lock My Mortgage Rate Today?
Well, maybe not this very second. But if you don't lock your rate prior to going shopping, when should you lock your loan? If you are concerned that interest rates might rise, or if your income barely qualifies for the loan you want, or if you would lose sleep at night unless you lock, lock your loan as soon as possible. Just remember: The longer the lock, the higher the cost, and if you are in contract on your new home and rates fall, you will not have enough time to switch lenders for a better rate and price.
Don’t Let a Fear of Mortgage Rates Stop You
If you are hesitant to shop for homes because you think interest rates are about to jump up, take heart. You can protect yourself and go shopping. There’s no such thing as an indefinite lock, so you’ll have a deadline, and you will pay a little for the peace of mind. But if interest rate concerns are what’s stopping you, several lenders have a solution, and the rest are likely to join them soon.