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Understanding Rate Locks

C Spaker
Christopher Spaker, AMP
President, CNB Mortgage Company
[email protected]
(585) 385-2370 x50955

 A mortgage loan cannot be closed without first locking in an interest rate. There are four components to a rate lock: the loan program, the interest rate, points and the length of the rate lock. The longer the length of the lock, the higher the points or the interest rate because the longer the lock, the greater the risk for the lender offering that lock.

Suppose you lock in a 30 year fixed loan at 6% and 2 points for 15 days on June 2nd. This lock will expire on June 17th. The lender must disburse funds by June 17th, otherwise your rate lock expires, and your original rate lock commitment is invalid.

The same lock might cost 2.50 points for a 30-day lock or 3.00 points for a 60-day lock. If you need a longer lock and don’t want to pay the higher points, you can usually pay a higher rate instead. After a lock expires, most lenders will allow you to relock at the higher of the prevailing market rates/points, or the originally locked rates/points. In most cases you will not get a lower rate if rates drop. In some cases, prior to the rate lock expiration date, the lender may allow you to negotiate a rate lock extension at the original rate/points but an additional fee may be charged for this extension.

Lenders can lose money if your lock expires because they are taking a risk by letting you lock in advance. If rates move higher, they are forced to honor the original rate at which you locked. Lenders often protect themselves against rate fluctuations by hedging. Some lenders offer free float downs where you can lock the rate initially and if the rates drop while your loan is in process, you can get the better rate. Keep in mind however, nothing in life is actually free. The free float-down is costly for the lender and you pay for this option indirectly, because the lender has to build the price of this option into the rate. For example, the float-down rate may be 0.125% to 0.25% higher than the prevailing current market rate when you lock initially.

So what happens if rates drop after you lock? Most lenders will not budge unless rates drop substantially (3/8% or more) because of the expense. If lenders let borrowers improve their rate every time rates improved, they'd spend a lot of time relocking interest rates, since rates fluctuate daily. Also, they would have to factor this option into their rates, and borrowers would wind up paying a higher rate. If rates drop, one option is to go to a different lender but you would be starting the loan process from the beginning and you may forfeit any fees already paid. Before applying with a different lender, inform your original lender that you are aware that rates have dropped. You may be pleasantly surprised to find that they will work with you rather than chance losing you to a competitor.

Have you ever heard of Lock-and-shop programs? Most lenders will let you lock in an interest rate only on a specific property, which means, if you are shopping for a home, you cannot lock in an interest rate until after you sign a purchase contract for a specific property. If you are shopping for a home, some lenders offer a lock-and-shop program that lets you lock in a rate before you find the home. This program is very useful when rates are rising, however lock-and-shop rates are usually higher than the prevailing market rate and the lender may charge a non-refundable fee or deposit towards closing costs.

And what about new construction rate locks? Most lenders offer long term rate locks for new construction. These locks do cost more and usually require an upfront deposit. For example, a lender might offer a 180 day lock for 1.250 points over the cost of a 60 day rate lock paid up front as a nonrefundable deposit. Some long term new construction rate locks also offer float downs. If rates drop prior to closing, you may get the better rate but make sure you understand the parameters of the program before locking.