Mortgage Rate Lock Provides Protection Against Rising Rates
Ready to buy a house but worried that mortgage rates will continue to rise as you’re searching? You might consider an interest rate lock, a service from mortgage lenders that could protect you from rising interest rates.
Just be aware that locks are a bit of a gamble: They protect you when rates rise, but could cost you if they fall.
How rate locks work
When you sign a rate lock agreement with a lender, that lender agrees to hold a specific interest rate for you for a set number of days. Most rate locks are good for 30 to 60 days.
Here's how it works: You might lock in an interest rate of 4.50 percent on a 30-year, fixed-rate mortgage with your lender for 45 days. If interest rates rise during this period, you're protected and the rate you locked in will stay in place.
Say rates jump to 4.75 percent. You'll still get a mortgage at the 4.50 percent rate you locked in as long as your rate lock hasn't expired. Of course, if rates go down after you lock in, you will lose your gamble. You'll have to close your loan at the higher interest rate because that's what the rules of your interest rate lock state.
There is one exception. Some lenders offer a float down provision. If rates drop during your lock period, you'll be able to close your loan at the lower rate. You'll have to pay more for a float down, though, and unless rates drop significantly after you lock in yours, the odds are high that paying for a float down won't make economic sense.
You’ll need to close your mortgage loan before the lock period expires. If you don't, and the 45 days pass, your interest rate lock expires. That’s why it makes the most sense to lock in a rate after you’ve signed a purchase agreement on a home. This should give you enough time to close that loan before your lock expires.
How much a rate lock costs depends on your lender. Some charge for these, while others lock your rate as a courtesy. Check with your lender to determine if your rate is locked and if you are being charged for this service.
Rate locks can bring peace of mind
Alexander Romanov, co-founder of online real estate company iwillbuyhouse.com in Lynnwood, Washington, said that rate locks can bring a sense of stability to buyers. There's no guarantee that interest rates won't fall after you pay for a lock. But at least you'll know what your final interest rate will be, Romanov said.
"Instead of having to deal with rising and falling interest rates, a buyer will have a fixed rate in mind and can budget accordingly," Romanov said. "Having to worry about the fluctuations on a day-to-day basis could be a daunting task. You can be at ease by locking in your rate and having an exact estimation of what your monthly debts will be."
This doesn't mean that there aren't cons to locking in your interest rate. The biggest is that you might miss out on a lower rate. If you lock in your rate at 4.65 percent for a 30-year mortgage and rates fall two weeks later, you'll miss out. Even if you might have qualified for a rate of 4.50 percent, you'll be stuck with the higher rate of 4.65 percent.
Robert Johnson, professor of finance with the Heider College of Business at Creighton University in Omaha, said that interest-rate locks make sense today.
"The vast majority of market participants believe that interest rates will rise, and rise substantially, in the future," Johnson said. "In an environment of expected rising interest rates, the ability to lock in a rate at current levels is extremely valuable."
Even if rates do eventually fall? Johnson says that homeowners have protection against this, too, because they can always refinance their existing mortgage loans.
Say you take out a 30-year fixed-rate mortgage today with an interest rate of 4.60 percent. If, three years from now rates have dropped, you might be able to refinance your mortgage to a new loan with a lower interest rate of, say, 3.80 percent.
This all depends on where rates head, how much home equity you've built and the strength of your FICO credit score. But refinancing is a safety valve for borrowers who worry that by locking in an interest rate today they'll miss out on lower rates in the future, Johnson said.
Looking at your own budget
Ralph DiBugnara, vice president at White Plains, New York-based Residential Home Funding Corp., said that it makes sense to lock in rates if you are comfortable with what your payment will be once you do so.
In other words, don't gamble that rates will go lower. They might. But they also might increase.
"Mistakes are made when consumers hope rates will go lower," DiBugnara said. "In a market like this, where the Fed is slowly raising the borrowing rate, when interest rates get better, they only get slightly better. When they get worse, they get a lot worse, and quickly."
Borrowers might feel more comfortable paying extra for a float down option. What's important to know, though, is that you can't rework your lock every time a rate dips. Rates have to hit a certain point for the float down provision to kick. DiBugnara said that rates usually need to drop .25 percent or more below the rate at which you locked in before your lender will rework your lock.
How much risk can you handle?
Larry Locke, a mortgage broker and owner of Pro-Funders in Murrieta, California, said that borrowers have to consider their own tolerance for risk when debating whether to lock in an interest rate
Locke said that many borrowers lock in a rate knowing full well that interest rates might fall. But they want to spare themselves the potential rollercoaster of worrying about rates.
"If they decide to wait to lock their rate, can their stomach lining take it if rates and pricing worsen?" Locke asked. "Can they deal with it if rates and pricing deteriorate for successive days? Some borrowers like to take the sure thing, and other borrowers like to try and beat the market and pick off the best available rate and pricing."