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Refinancing Your Mortgage? Look Beyond Getting the Rock-Bottom Interest Rate

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You’ve decided it’s time to refinance your mortgage at a lower interest rate, and perhaps you’re agonizing over what’s known as the lock. Rates fluctuate, so you have to decide whether to commit to the rate now or wait, hoping for a decline that will lower your monthly payment even more.

Our research, based in part on data from Lenda, a popular online refinancing lender, delved into the decision on whether to lock or wait. Here’s what you need to know.

How refinancing and rate locks work

The refinance process works like this: You complete an application with a mortgage broker or lender, ideally at least three, to compare the rates you qualify for and loan costs. Once you’re initially approved, you usually have the option to lock your rate while your loan goes through underwriting.

Locking guarantees that interest rate for a specified period, even if rates rise. However, if rates fall after you’ve locked, you won’t get a lower rate. The lock typically lasts a week to several months, depending on the lock period you choose, but you want to make sure it’s long enough to close on your loan before the lock expires. Some lenders allow borrowers to float a rate instead of lock; in other words, you’d get a lower rate if rates drop before you close. But this also means you’ll pay a higher rate if they tick up.

Keep in mind that longer rate-lock periods cost you in terms of the interest rate on your loan, as lenders seek to minimize their potential losses. According to mortgage software provider Ellie Mae, in May the average time from application to close was 45 days. Mortgage rates are often quoted in 15-day “windows,” and with each additional 15-day period of the lock, lenders raise the interest rate by 12 basis points, according to The Mortgage Reports. One basis point equals one-hundredth of a percentage point.

One lesson here is that rather than worrying so much about getting a rock-bottom rate, mortgage applicants should refinance with a rate-competitive lender that can close the fastest.

Look beyond the rock-bottom rate

If you don’t manage to lock your refinance loan when rates are lowest, the difference in potential savings typically is minimal over short periods of time. Lenda analyzed data from Freddie Mac’s monthly mortgage survey, which showed that refi rates didn’t change significantly week to week between July 2015 and May 2016, so consumers who missed the optimal rate didn’t miss it by much.

Over this 43-week period, the largest week-to-week change for 30-year loans was a decrease of 12 basis points, and in some weeks rates stayed the same. Comparing two-week periods, the largest change was an increase of 22 basis points.

Let’s say you do miss the lowest rate by 12 basis points and you’re refinancing a 30-year home loan with a balance of $191,760, the median sale price for existing homes in the U.S. in May, according to the National Association of Realtors, minus a 20% down payment. You refinanced at 3.8%, but a week later, the rate drops 12 basis points, to 3.68%. You would have saved $14 per month from refinancing at an interest rate 12 basis points lower. But keep in mind that rates could have moved the other way, and you’d have ended up paying more each month.

On rare occasions, mortgage rates tumble. When U.K. voters in June approved an exit from the European Union, mortgage rates in the U.S. fell 26 basis points during the following eight business days. If you had locked in your refinance just before the vote, you’d have missed that decline. In such a case, you could seek to renegotiate for the lower rate with your lender or abandon your application and start again. You would face another pile of paperwork and likely lose your application fee, but capturing that quarter-point would save you about $28 a month based on our example above, a not inconsiderable amount.

Some people who refinance do wait to lock, for various reasons. Perhaps they are anticipating rates will fall, or maybe they haven’t paid attention to the lock clause in the mountain of paperwork they signed. Some 276 borrowers who refinanced with Lenda over a 43-week period waited a median of three days to lock their rate after being approved. However, 30% of these refinancers waited at least a week to lock and 19% at least two weeks, even though they could have locked almost immediately.

Waiting to lock may be rolling the dice

It’s unclear why some people don’t lock right away, when there’s no way to be sure which direction rates will go from day to day. The U.S. has been in a falling rate environment since about 2010, and that mindset may be at play when consumers weigh the lock decision.

Locking a rate ensures you’ll pay the promised rate regardless of what happens in the market.

“For anybody who’s looking to really time it right as you near these peaks, the air becomes very thin and you’ve got to be ready to give up everything you’ve worked for,” says Jim Sahnger, a mortgage loan originator with Schaffer Mortgage Inc. in Palm Beach Gardens, Florida. Trying to time interest rates is simply rolling the dice, he adds.

“If you lock the rate, you know what you have,” he says. “The moment you make the decision to apply, the rate being offered at that point makes sense to you.”

If getting a refi is ideal for your personal financial situation, it may be wise to act when you see a rate you know you can afford rather than waiting for rates to drop. Floating the rate does give you a chance to end up with a better rate, but it also puts you at risk of losing money by getting stuck with a higher rate. It’s especially risky for borrowers who want to take out the biggest loan they can qualify for.

Refinance rates at mid-year 2016 were the lowest they’ve been in decades, so they can’t go much lower. This reduces the possibility of a benefit from waiting even longer.

Not sure if it’s the right time to refinance your mortgage? Use NerdWallet’s mortgage refinance calculator to see how much you could save and if it makes sense for you.

Methodology

To calculate cost differential of 12 and 26 basis points: We used the example of a 30-year loan with a balance of $191,760, based on the median sale prices for existing homes in the U.S. in May of $239,700, according to the National Association of Realtors. We subtracted 20% for a down payment. We calculated monthly payments at the interest rates of 3.54%, 3.68% and 3.8%.

Emily Starbuck Crone is a staff writer at NerdWallet, a personal finance website. Email: emily.crone@nerdwallet.com. Twitter: @emstarbuck.