Question: We’ve been speaking with a mortgage lender and she said that in the face of rising rates that now would be a good time to get a lock-in. What is a lock-in and what does it do for us?
Answer: When you begin the mortgage application process it’s understood that the financing will not be completed for six weeks or so. In February, as an example, Ellie Mae found that the typical mortgage took 37 days for a refi to close and 45 days for purchase financing.
Because the moment of application and the date of settlement are far apart there is the very real question regarding what interest rate you will pay. Will it be that rate when you first applied for a mortgage or the rate in place at the time of closing? Depending on market conditions they could be very different.
Lock-in Proof
If you look at the Loan Estimate (LE) form provided by the lender you will see at the top of page one that there’s an area to show whether the mortgage rate was locked at the time of application or if you have elected to allow the rate to float.
Some points to consider:
First, the general idea is that borrowers should lock if they feel rates might rise in the next few weeks.
Second, it’s not enough to lock just the interest rate. The LE form doesn’t ask if you want to lock just the “interest rate” but the “interest rate, points, and lender credits.” The reason for such language is that if you only lock the interest rate the lender can charge extra points or reduce the value of closing credits. The government form makes certain borrowers get a real lock.
Lock-ins — are they free?
Third, does the lender charge for the lock? With many lenders there is no lock fee – and if there is you can shop for other mortgage offers. However, for a longer lock, say 60 days, there is likely to be a lock fee to compensate the lender for the risk represented to them for the longer lock.
Third, many lenders offer a one-time rate change, sometimes called a “float down” option. In other words, if you have locked at 4.50 percent and there’s a downward shift before closing you might be able to lock at 4.25 percent. Some lenders will do this automatically, some won’t. In effect, your rate will never be higher than the original lock figure (4.5 percent in this example) and it could drift lower with a float down. Always ask if there is a float down fee and if the float down only applies in situations where there is a minimum rate drop, say a quarter or an eighth of a percent.
Fourth, if you cannot close within the lock period you can lose the protection against higher rates. If the lender causes the delay you can argue that they need to continue the lock at no cost, if the delay is because you did not provide paperwork then it’s a cost to you. To avoid a blown rate lock always have application paperwork prepared in advance (bank statements, tax returns, etc.), get requested information to the lender immediately, and obtain a receipt for the paperwork you send over so there’s dated evidence of delivery.
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Lock-ins and risk
Fifth, you often hear about the “risk” of floating but there is risk no matter what you do.
If you lock-in a rate and mortgage costs suddenly fall you will lose the opportunity to finance at a lower cost. If you have a float-down agreement you have a one-time chance to capture a lower rate. The risk is that rates might keep falling.
With a floating rate, the risk is that mortgage rates might rise prior to closing. However, for the lender, there’s the risk that rates might drop.
When you make a financial decision there’s always the possibility that the choice will be wrong. However, if you do nothing there is also the risk that you might not be better off. In economics, this is generally called an “opportunity cost.”
Different people have different rate lock philosophies. For me, the best option is a free rate lock with an equally-free float down provision plus a fierce effort to assure that the lender receives all requested information as quickly as possible. Your approach might differ and that’s okay because no one knows what will happen to rates in the future.
