Obtaining the lowest available interest rate on a mortgage should be every would-be homeowner's objective. Lower interest rates result in lower monthly payments, so you should spend a lot of time and effort searching for the best rate. If you do, you'll probably find the most competitive one available.
Now for the Bad News
While advertising may have lured you in with an impressively low rate, that rate might not be available months from now when you close on your mortgage. The rate that you saw in the newspaper or online ad was the "rate quote", which simply means that it is the rate available at that particular point in time. Mortgage rates change from day to day, rising and falling in patterns that are not always easy to anticipate. To make sure that the rate you actually pay is the rate that you want, you need to lock in that magic number with a mortgage rate lock. We'll show you how this tool can help you save money on your mortgage.
What Is a Rate Lock?
A mortgage rate lock is an agreement between a borrower and a lender that guarantees the borrower a specific interest rate on a mortgage. Rate locks are important because interest rates change frequently and the mortgage application process can be time consuming. The rate that was in effect on the day you applied for your loan may not be the rate that is available weeks later when your loan is approved.
Similarly, the rate that was in effect when your loan application was approved may not be available months later when you complete the purchase of the home. Policies vary by lender, but borrowers often have the opportunity to lock in a specific interest rate either at the time the loan application is filed, at some point during loan processing, or once the application has been approved.
Locking in Savings
Locking in a rate is an important part of the mortgage process because of the role interest rates play in determining not only your monthly mortgage payment, but also the amount that you will spend over the lifetime of the loan. Consider the payments on a $100,000 loan at the following interest rates:
|Rate||Monthly Payment||Total Interest Paid Over 30 Years|
A 1% difference in interest rates results in the payment of an additional $65 with each month's mortgage payment. That comes to $780 a year and $23,400 over the lifetime of a 30-year mortgage.
When to Lock
There are clear reasons to lock in a rate, and because of the fear of rising rates, many borrowers rush to lock in a rate as soon as possible. While this might seem to be a good strategy, it isn't necessarily the best course of action in all situations.
While lower interest rates help borrowers save money, locking in a rate often comes with a cost. Some lenders charge a mortgage rate lock deposit, while others provide a rate lock in exchange for an interest rate that is slightly higher than the prevailing rate at the time the lock is enacted and/or require borrowers to pay a specific number of points in order to obtain the desired interest rate. The points may be fixed or floating. Fixed points refer to a set number of points; with floating points, the interest rate is locked in, but the number of points that must be paid to guarantee the rate can change over time.
Many lenders operate within a tiered system. Rate locks for 30 days or less are usually free. Some lenders extend free locks for 45 days or more. Longer time periods include incrementally higher fees, often rising in tandem with 30-day increases in the lock-in period. A 90-day lock will cost more than a 60-day lock; a 120-day lock will cost more than a 90-day lock. A quarter-point in additional fees for each 30-day extension is common, although fees vary widely by lender.
If the loan fails to close prior to the end of the lock-up period, the guaranteed rate expires, and any deposit that you made may be forfeited to the lender. If the expiration date passes because of something that you did or failed to do, you may be out luck, but if the date passes as a result of an action or inaction by the lender, the agreed-upon rate may still be available.
Locks Don't Provide Unlimited Protection
While locking in a specific interest rate protects borrowers against rising interest rates, it may also prevent them from taking advantage of falling interest rates. Some lenders offer a mortgage rate lock float down, which enables borrowers to make a one-time election to exchange their current rate for a lower rate if rates have fallen. Find out whether a lender offers a float down prior to entering into a rate lock agreement.
Even with a rate lock and a mortgage rate lock float down, it is possible to end up paying a higher interest rate than the rate that you agreed to when you signed for the lock. This occurs because many lenders include a "cap" with the lock agreement. The cap permits the guaranteed rate to rise if interest rates rise prior to settlement. The cap does set a limit on the amount the rate can rise, so it provides some protection against rising interest rates.
Time to Shop
When contemplating a mortgage, shopping for bargains is a good policy. Because rates and fees can vary significantly, checking out offers from multiple lenders can result in some serious savings. In addition to shopping around, be sure to get rate locks in writing. Rising rates mean rising profits for lenders, so they have every incentive to increase the rate whenever possible.