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What is a mortgage rate lock?

When getting a home loan, one of the biggest concerns is the interest rate you get.  Interest rates can change daily, sometimes hourly, and also vary based on loan type (like Conventional, FHA, VA loans), purpose of the loan (purchase, refinance, owner occupied home, investment property), credit scores, and when is the loan closing.

Once your Loan Officer has determined all of those items, you will be quoted an interest rate and closing cost combination based on interest rates available on that day, and based on when you anticipate closing the loan.

You can then choose to lock the interest rate, or float the interest rate. Locking is exactly what the name means. Locked. If rates go lower before closing, you DO NOT get the lower rate. On the other hand, if rates go higher before closing, the lender can NOT increase your interest rate either.  Floating means just the opposite. You are NOT locked, and you are gambling that interest rates gets better. Most lenders will require you lock a rate no later than about 10-days prior to closing so they have time to prepare the paperwork with the exact rate, send proper disclosings to you, etc.

Interest rates and lock periods

When you're locking in a rate, lenders have to secure funds today for your future closing date when they need to write a check. Lenders hedge their interest rate risk, so the longer out from the day of locking to the day of closing, the more risk to the lender of market changes. This simply translates into slightly higher interest rates for the longer lock periods.

Most online, newspaper, and generic interest rate quoting is based on a 30-day lock.

For example:
a 15 day lock rate may be 4.25%%
a 30, or 45 day lock rate may be 4.375%
a 60 or 75 day lock may be 4.500%
a 120 day lock may be 4.750%

To lock in for longer periods than 75-days, a consumer would likely pay a nonrefundable lock fee that would be forfeited if the consumer broke the lock. This is typically 1/2 to 1% of the anticipated loan amount.

The lack of upfront fees in the short-term locks seems to make walking away from a rate lock a painless exercise, but you should think again.

Think twice BEFORE you break the lock on that mortgage rate

You've locked yourself into a good mortgage interest rate for 30-days and you are very happy. You expect to close a month from now, on the house you want, at a payment you can afford. Suddenly, interest rates start to drop and the rate you've locked in doesn't look quite so good.

Why did you lock in the rate in the first place? Because a rate lock is a form of insurance to keep the interest rate from escalating to the point where monthly payments on your proposed loan become unaffordable. The only time such locks become an issue for cost-conscious consumers is when rates are dropping and each fraction of a percent represents a savings over the locked rate.

For example, take a $125,000 30-year fixed-rate loan. The monthly payment at 5.00% percent interest works out to $671.03. At 4.875%, it goes down just $9.52, to $661.51. Over the full course of the loan (30-years), that represents an extra $3,427.20 in your pocket.. Sounds nice... but...

Pause BEFORE you Break a Rate Lock

If you're tempted to break a rate lock and head for another lender, experts warn that you should tread carefully and consider the time and expense that breaking the lock can incur.

Breaking rate locks is easy to do. One simply walks away and does not close the loan. However, there could be expensive repercussions to that action.

Consider the costs involved in chasing a lower interest rate ... could be numerous, from a forfeited application fee to the loss of nonrefundable fees paid up front, to being billed for expenses incurred by the lender (like appraisal), to a variety of expenses to be reimbursed the seller, the real estate company, or both, as well as other vendors involved in the transaction, to being sued by a lender or other party to the transaction. Review your rate lock form. Most spell out exactly what the lender will do if you break the lock. 

Be sure you'll benefit from a lower interest rate

Real Quotes?  Real Rates?  Real Comparison?

Be 100% sure you are getting real rates, and real cost quotes that are truly Apples-to-Apples. For example, I have been working with a client for a few weeks who just called to ask me if I could match the big bank?  Match?  Crazy talk I thought, as the banks almost always need to match us, not the other way around.

As I talked to the customer, I discovered the entire story.  While I have a full application, including an appraisal and credit report - he had only talked to them for about 5-minutes over the phone.  I knew his middle credit score was just 681.  I knew he was doing a cash-out refinance.  I knew his loan-to-value was 80%.  I accurately quoted him for his personal situation.

He had decided to call the bank because of a sandwich board displaying rates in their drive-thru while depositing a check, because it appeared to him to be better than my accurate quote.

Of course he only spoke to the bank person for 5-minutes. The bank NEVER asked the correct questions, NEVER had an application, NEVER saw his credit report, and didn't have an appraisal. The quote the bank gave him would have been real, had he been under 70% loan-to-value, had a credit score over 740, and was not taking additional cash-out.

Of course I still beat the banks quote for the same situation - but the point is that he was NOT comparing Apples-to-Apples...

MN, WI, and SD Only

Refinance Rate Locks

The least-risk scenario for breaking a rate lock is in a refinancing transaction, where there is no time constraint on the consumer seeking the refinance loan.

In a refinance transaction, the borrower can just wait to see what happens. If interest rates go down, he can threaten to walk away from the deal unless his rate is reduced. When rates are dropping, a lot of borrowers start doing this to lenders. If a lender locks a loan that doesn't close - it costs them. As with anything else, lenders need to price in the losses, and pass them on to everyone else. I have found a consistent tendency for refinance interest rates to be priced as much as a quarter of a percent higher than purchase loan interest rates.

Contrary to what consumers think, a lender can not just change a locked interest rate because you asked them to. It just doesn't work that way. But, depending on a large number of variables, you may be able to get a lower rate from your current lender if rates have dropped.  Just ask - but don't be shocked if they say no.

SIDE NOTE: Refinancing with your current lender generally feels like the right thing to do. Almost without fail, you will get a better deal if you shop your refinance somewhere else!

How Rate Locks Work From the Lenders Standpoint

When your mortgage company locks your mortgage rate, it sets in motion a whole series of events behind curtain. I'll save you all the details, but understand they can't just arbitrarily change your rate lock. The percentage of locked loans that never close (known as fallout) is closely monitored. From the moment we lock a loan, we hedge our interest-rate risk to guarantee you that we will have the money to fund your loan at closing. If market prices (our cost of money) improves during the lock period, we lose money on the hedge. If the loan never closes, we are totally out the hedge money. This can (and does) add up to millions of dollars of losses that get passed on to you with higher rates. The rate lock goes both ways. If rates go down, you don't get the lower rate.  if rates go up, you won't be charged more.  Funny how homeowners are only concerned when rates go down.

Interest Rate Float Down Options

For protection on both ends of the scale, some lenders have "float-down" provisions. In these contracts, the consumer locks in a rate, and if rates come down, the consumer has the opportunity to lock in a new lower rate once before closing. But, take note. These loans are usually priced a little higher to begin with because the lender's taking that risk.

Some lenders offer float down options, which means once locked, you have a one time opportunity to lower the rate if rates go down. This sounds great, but comes at a cost, and you must inform your loan officer you wish to exercise this option PRIOR to the initial lock.

The most common option works like this:  Assume the real 60-day lock rate is 4.25%.  If you want the float down option, you need to lock at 4.375%.  Then rates must move at least 1/4% lower in order to lower your rate.  Meaning the rate must have moved down to 4.125% in this example. In my humble opinion, other than very long-term locks (more than 60-days), it isn't worth bothering for most people.

The bottom line
In the end for almost everyone, chasing anything but a significant drop in interest rates, something which likely won't happen in the normal 30 to 45 days it takes to close a loan, is futile because of what consumers pay for changing their minds.

I get people calling me saying, 'Well, let's go ahead and start the paperwork. Then, when we reach the low point we'll lock it in.'" I've done this for years and I don't know where the low point is ... so people need to have realistic expectations. Otherwise, they are just filling out paperwork for no good reason.

Remember, it is extremely hard for anyone to catch the rock bottom of interest rate cycles. It is easy to get near the bottom. Be realistic. If you are comfortable with the rate, lock. Then don't look back!

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