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Do I really need to opt for a "rate lock"?
What is a rate lock?
You cannot close
a mortgage loan without locking in an interest rate. There are
four components to a rate lock:
1. Loan program.
2. Interest rate.
3. Points.
4. Length of the lock. |
The longer the length of the lock,
the higher the points or the interest rate. This is because the
longer the
lock, the greater the risk for the lender offering that lock.
Let's
say you lock in a 30-year fixed loan at 8% for 2 points for 15
days on March 2. This lock will expire on March 17 (if March
17 is a holiday then the lock is typically extended to the first
working day after the 17th). The lender must disburse funds by
March 17th, otherwise your rate lock expires, and your original
rate-lock commitment is invalid.
The same lock might cost 2.25 points
for a 30-day lock or 2.5 points for a 60-day lock. If you need
a longer lock and do not want to
pay the higher points, you may instead pay a higher rate.
After
a lock expires, most lenders will let you re-lock at the higher
of the original price and the originally locked price. In
most cases you will not get a lower rate if rates drop.
Lenders
can lose money if your lock expires. This is because they are taking
a risk by letting you lock in advance. If rates move
higher, they are forced to give you the original rate at which
you locked. Lenders often protect themselves against rate fluctuations
by hedging.
Some lenders do offer free float-downs––i.e.
you may lock the rate initially and if the rates drop while your
loan is
in process, you will get the better rate. However, there is no
free lunch––the free float-down is costly for the lender
and you pay for this option indirectly, because the lender has
to build the price of this option into the rate.
What do you do
if the rates drop after you lock?
Most lenders will not budge unless
the rates drop substantially (3/8% or more). This is because it
is expensive for them to lock
in interest rates. If lenders let the borrowers improve their rate
every time the rates improved, they spend a lot of time relocking
interest rates, since rates fluctuate daily. Also they would have
to build this option into their rates and borrowers would wind
up paying a higher rate.
Lock-and-shop programs.
Most lenders
will let you lock in an interest rate only on a specific property.
If you are shopping for a house, some lenders offer a
lock-and-shop program that lets you lock in a rate before you find
the house. This program is very useful when rates are rising.
New-construction
rate locks.
Most lenders offer long-term locks
for new construction. These locks do cost more and may require
an up-front deposit. For
example,
a lender might offer a 180-day lock for 1 point over the cost of
a 30-day lock, with 0.5 points being paid up-front, as a non-refundable
deposit. Most long-term new-construction locks do offer a float-down––i.e.
if rates drop prior to closing, you get the better rate.
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