Economists and financial types love to talk about interest rates. But if you’re like many other Americans, you think that topic is about as exciting as foreign exchange rates.
Until you buy a home or refinance your mortgage.
Then, you start to really care about interest rates, at least until your loan closes. After all, even a small change in the interest rate on your mortgage can mean paying thousands more or less over the life of your loan.
A rate lock, or mortgage rate lock-in, is one loan feature you’ll want to consider. Before you decide, it helps to know how rate locks work, the downsides and how much one costs.
How a rate lock works
Your mortgage lender will probably offer a rate lock once your loan application has been approved. Once locked, the loan’s interest rate can’t change. You’re protected from higher rates, but you won’t get a lower rate either.
Some lenders charge for a rate lock, though others offer one for free. Like any other “free” service offered by a lender, it’s baked into the rate you’re offered. If you do pay for a lock, fees vary widely according to the amount and term of the loan, as well as the length of the lock-in period, and are measured in basis points, such as 25 bps, or 0.25% of the total loan value.
Select a lock period that allows plenty of time to closing. Mortgage closings can take 30 to 90 days, and you might want to err on the side of caution. It seems there’s always a delay of some kind.
What happens when interest rates stay the same?
It could happen. Mortgage rates can dance around for weeks, going up or down a notch or two — and end up right where they started when you began the process. In that case, you might feel as though whatever you paid for the rate lock, if anything, was wasted. But remember, your goal was to prevent rising rates from rocking your budget. A rate lock ensures that they won’t.
What happens when home loan interest rates go up?
This is the best possible scenario: If rates go up, you’re protected. Your interest rate is set. That’s when a rate lock is well worth the price.
What happens when mortgage rates go down?
However, rates might also go down before your closing. Unless you have a rare — and often expensive — one-time “float down” option on your lock, you’ll miss the markdown. (A float down option is most often associated with new construction loans and longer-term rate locks.)
A rate lock does entail some risk. You could forgo getting a rate commitment from your lender, but rather than losing out on a lower rate, you’ll be chancing a higher payment. Better yet, don’t sweat the savings you’ll miss if rates drop a bit before you sign the loan. Remember, there are a hundred reasons for rates to move up or down moment by moment — they’re out of your control. With a lock, your rate is protected. Everything else is just noise.
Is a mortgage rate lock worth it?
If you can afford a rate lock it’s a good idea. The benefits far outweigh the risks. An interest rate lock isn’t an attempt to “get the best loan deal.” Hopefully, you shopped rates among several firms before deciding on a lender. The lock is protecting your homebuying power. By nailing down your rate, you prevent your mortgage payment from going up due to a rash of rate hikes before your closing.
Consider a $300,000 home financed for 30 years at 4%. Just a quarter point (0.25%) rise in interest rates will kick your payments up $44 a month, from $1,432 to $1,476. Over a six to eight week period, from entering into a contract to signing the closing documents, it’s quite possible for rates to move much more than that.
Worst of all, not locking in a rate can mean a higher down payment. As your payments rise with higher interest rates, a lender may require more money upfront in order to meet its lending requirements.
Predicting home loan interest rates is like forecasting the stock market: It can’t be done. Rates are up one day and down the next. Even noted economists who insist on declaring long-term trends are often wrong. Lock your rate and move on to something less nerve wracking. Perhaps planning your new home’s decor.
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