How Do Rate Locks Work?
In most cases when you shop for a loan, the rate and terms you are
quoted represent those available that day. The rate quoted
probably won't be available next month or next week. Therefore,
you should only rely on the rate and terms a lender is willing to
lock-in.
A lock-in, or rate commitment, is a lender's promise to close
your loan at a certain interest rate and number of points.
Depending upon the lender, you may be able to lock in the interest
rate and points upon submitting your application, during
application processing, upon loan approval, or later. A rate lock
protects you against rate increases while your application is
being processed. However, a locked-in rate could cost you money in
the event rates drop and you want a lower rate.
You will need to lock the rate on your mortgage some time prior
to closing. There are five components to a rate lock:
- Loan program
- Loan amount
- Interest rate
- Points
- Length of the lock
You must identify each of the above mentioned items in a rate
lock. A rate lock might look something like this: 30 year fixed,
$150,000 loan amount, 7.5 percent, one point, 30 day lock period.
The document describing the lock will contain the date the lock
was made and usually the lock expiration date. The lender must
disburse funds prior to the expiration of the lock period,
otherwise, the rate lock is invalid.
A loan with a below-market interest rate is less attractive to a
potential purchaser of the loan. The longer the lock period, the
greater the risk that interest rates will increase before the loan
closes. To offset this increased risk, the lender charges
increasingly higher points and/or interest for longer lock
periods.
If rates increase during the lock period and your lock expires,
most lenders will let you re-lock at the new, higher rate or
points. If rates decrease during the lock period and your lock
expires, lenders usually will charge a penalty to take advantage
of the new, lower rates. For a fee, some lenders allow a
"float-down" option which allows you to take advantage of
decreasing interest rates. Once a lock expires, be prepared to
renegotiate the rate and points.
Unless you have the option to float-down, most lenders will not
budge unless rates drop substantially (3/8 percent or more).
Lenders incur fees when they lock loans. If lenders were to allow
borrowers to cancel a lock every time rates improved, they'd spend
too much time re-locking rates, and the increased costs would have
to be passed to borrowers.
Most lenders will let you lock an interest rate only in
connection with a specific property. Some lenders offer
lock-and-shop programs which let you lock a rate before you find
your home. Both programs can be valuable when rates are rising.
Most lenders offer long-term locks for new construction. Since
these locks tend to be relatively long, they can be expensive. An
up-front deposit is sometimes required also. Most long-term new
construction locks offer a float-down. |
