Buyers: Here’s How To Decide Whether You Want A Mortgage Rate Lock

Applying for a mortgage involves a number of terms that you might not have ever heard, and when your loan originator asks you whether you want to lock in your mortgage rate, you might not have a clue what they mean. But this isn’t a question that you should ignore; it can (and will) impact your mortgage payment from the very first month. What’s a mortgage loan rate lock, anyway?

A rate lock is an agreement you make with your mortgage lender to guarantee your interest rate while they work to close your loan. Locking in a rate is an essential step to getting a home loan.

If nothing else, when you sign the papers to finalize the loan, that will definitely lock in the rate. However, a rate lock is also something you can do much earlier in the process. It’s an important way to manage risk and control costs.

Here’s what you need to know about mortgage loan rate locks, what they can do for you, and when and how you can put one in place.

A lock representing a mortgage loan rate lock.
Source: (iMattSmart / Unsplash)

What’s a mortgage loan rate lock?

As you already know (or will soon learn), the interest rate on your home loan is one of its most important features. A lower rate is better because it means you’ll be paying less interest, and the loan won’t cost you as much over time.

The interest rate can noticeably affect your monthly payment — the higher the rate, the bigger your payment will be. And over the life of a typical mortgage, even small differences in the loan’s interest rate can make a difference of thousands or even tens of thousands of dollars in the total amount you’ll pay to own your house free and clear. (More on that in a minute.)

With this in mind, when you’re shopping for a loan, the interest rate that lenders offer will be a major consideration. However, interest rates change constantly according to the tides of the financial markets. The rate you are quoted today is only today’s rate. Tomorrow’s rate is often not the same.

That’s important because it typically takes weeks to close on a mortgage loan. Your lender needs that time to evaluate your loan request and prepare the necessary documents.

During that time, interest rates can — and often do — go up or down by significant amounts. So how can you be sure that the interest rate that attracted you to your lender and your loan will actually be the rate on the loan documents you eventually sign?

The answer is the mortgage loan rate lock. Some lenders and brokers may also refer to it as a lock-in or rate commitment. By any name, this is an agreement your lender makes to guarantee that the interest rate you agree to pay today will be the rate on your loan documents when you sit down for closing.

Without a rate lock, the interest rate you finally agree to may have floated above what you planned to pay. It may make the loan a lot less attractive. It may even be more than you can afford!

Luckily, a rate lock is a common feature of most loans. Many experts not only recommend rate locks to others but also use rate locks themselves when they are taking out a mortgage.

“We have a wide range of customers — like myself — that always immediately lock as soon as they can,” says John Boyles, director of capital markets for HomeLight Home Loans.

“I never float. If it’s a rate I like, I take it.”

Rate locks as a risk management tool

Boyles explains that he is a risk-averse borrower. More certainty around the cost of the money he’s borrowing gives him peace of mind.

It also lets him plan for the future with confidence because he can correctly anticipate his mortgage payment amount. That’s also true of ordinary borrowers who are similarly wary of taking on too much risk.

“When they lock their loans, they’re transferring the risk of the rate rising during the time it takes to process the loan.,” Boyles explains. “They’re giving it to the lender, broker, or loan officer, so they are now responsible for handling that interest rate risk.”

This doesn’t mean you have to agree to a rate lock. But it may suggest that a rate lock is something to look into. To begin, let’s check out the major features of a rate lock.

The main elements of a mortgage rate lock agreement

Here’s what is covered in a typical rate lock agreement:

  • The date the rate lock agreement goes into effect; usually, this is the day you agree to the lock
  • The date the rate lock expires — typically 30, 60, or 90 days from the date it starts
  • The actual rate you’re locking in (expressed as a percentage)
  • The cost of the rate lock — shorter rate locks are often free, but lenders may ask you to pay 0.25% to 0.50% of the loan amount for a longer rate lock
  • The mortgage program you’re using, including whether your mortgage rate is fixed (set for the life of the loan) or adjustable (will fluctuate, typically after an introductory fixed period), and the loan term, such as 15 or 30 years
  • Any discount points you may be paying to get the offered rate

A rate lock agreement often will include a float-down provision that describes what happens if rates go down before your closing. It also covers what happens if you don’t close the loan before the rate lock expires.

An abacus used to represent calculating a mortgage loan rate lock.
Source: (Crissy Jarvis / Unsplash)

Why would you want a mortgage rate lock?

The short answer to why you might want a rate lock is simply because rates are moving constantly, and even small changes can add up to a lot of money over years and decades.

Historical rate information from Freddie Mac shows that rates are almost never the same from one month to the next. While most monthly differences are around one-tenth of one percentage point or thereabouts, it’s not unusual for rates to vary by as much as a quarter of a percentage point or more during the course of a single month. That might sound like a small amount, but these fluctuations can make a significant difference in your monthly payment.

Let’s look at an example: You are buying a $300,000 home and putting $60,000 down (20% down). You’ll borrow $240,000 with a 30-year mortgage, and you can lock in your interest rate today at 3.5% without spending money on points (which you buy upfront to decrease your mortgage interest rate).

If you lock your rate in today, your estimated monthly payment will be $1,361.04, including estimated escrow payments for taxes and insurance. Over the 30-year life of the loan, you’ll pay a total of $147,974.61 interest.

In this hypothetical example, you decide not to lock in your rate. By the time you close, rates have climbed to 3.75%. This quarter of a percentage point difference means your monthly payment will now be $1,394.81, and the total interest you’ll pay has climbed to $160,131.87. That’s an increase of $12,157.26 over the life of the loan.

The $33.77 increase in the monthly payment might not seem significant, but remember that any increase in the monthly payment increases your debt-to-income ratio. Debt-to-income compares your total monthly debt payments to your total income. If this figure slips below the acceptable level — many lenders look for a ratio below 43% — you may have to come up with a bigger down payment to qualify for a loan.

What’s the cost to get a rate lock?

Sometimes you will have to have to pay for a rate lock. According to Boyles, however, that’s unusual. “It’s not a common practice within the industry to charge a rate lock fee,” he says.

If you are asked to pay a rate lock fee, it will likely be about 0.25% to 0.5% of the loan amount. On that $300,000 home with a $60,000 down payment and $240,000 loan, this comes to between $600 and $1,200.

How long does a rate lock usually last?

Rate locks are for a specific period of time, usually 30 or 60 days, but they can sometimes be valid for up to 120 days. It depends on the lender and the specifics of your loan. To make a smart decision about a rate lock, you need to know how long it’s likely to take to close on your loan.

The average time to close a home loan in August 2020 was 49 days, according to data collected by loan tech firm Ellie Mae. Purchase loans averaged 45 days, while refinance loans took 51 days.

These numbers may vary by a few days from one month to the next, depending in part on how busy home lenders are. But you can usually expect a mortgage loan to take about that long to close.

Extending your rate lock

So what happens if the expiration date on your lock arrives and, for some reason, you haven’t been able to close? In this case, you may be able to extend your rate lock long enough to close under the locked rate.

The catch is that a rate lock extension may cost you another 0.25% to 0.50% fee. This is not always the case. One question to ask your lender is what an extension will cost, if anything.

Mortgage rate lock float-downs

A float-down provision is often part of a rate lock agreement. This will let you reduce your rate if market rates go down while you are locked and waiting to close.

The catch is that you may have to pay around 0.50% of your loan amount for a float-down. How can you decide if it’s worth it?

Let’s go back to the previous example of a $300,000 purchase with $60,000 down and a lock-in rate of 3.5%. If rates decline by a quarter of a point to 3.25%, the monthly payment at that rate would be $1,327.83. That saves $33.21 on the estimated monthly payment and $11,956.35 interest over 30 years.

If you plan to stay in the house for at least 10 years, you know you’ll be making 120 payments. At an added $33.21 per month, the cost of staying with your lock-in rate will come to $3,985.20. If your lender charges you 0.50% of $240,000 for the float down, that would cost $1,200. So the choice of paying for a float down will come down to whether you want to spend $1,200 now to save $3,985.20 over 10 years.

However, you won’t necessarily have to make the choice because you won’t always be asked to pay for the float down. “You shouldn’t have to,” Boyles says. “Generally speaking, most lenders won’t charge customers for a float down.”

A calendar that will help you with a loan rate lock.
Source: (Maddi Bazzocco / Unsplash)

When should you lock in your mortgage rate?

Rate locks are all about timing. Lock too early and you might not close before the lock expires. If you wait, rates could rise. Here’s how to decide when to lock your rate.

You’ll likely get your first chance to lock your rate early in your discussions with the lender, and you will continue to have the opportunity to lock as you submit your application and your loan is processed.

Generally speaking, Boyles recommends locking in an acceptable rate as soon as you know when your estimated closing date will be. That way you can be relatively confident that your rate won’t expire before your closing date.

“There’s no timing the market,” he adds.

“Generally speaking, if you see a rate you like, you should lock it up.”

Locking into a rate doesn’t mean you’ve locked in all the other terms of the note. For instance, if you later decide to make a larger down payment or switch from a 30-year to a 15-year term, you can still apply the interest rate lock (and thereby, the rates that would have applied to that program on the date the loan was locked) to the modified loan program, Boyles says.

Can you get out of a rate lock?

Once you’re locked in with your lender, you generally can’t unlock your rate unless you use a float down.

You do always have the option of applying with another lender to get a better rate. However, this could delay your closing date, and the delay may put a purchase deal at risk, so you’ll need to weigh the pros and cons of the lower rate with the potential for lost time on a purchase. This delay is much less critical on a typical refinance which tends to have a more flexible timeline.

It’s a good idea to talk to your mortgage professional about why you want to modify your lock. Many terms on a loan are negotiable, and you may be able to work with your lender to modify the terms of your loan in a way that the rate you are locked into is acceptable, Boyles says.

A door of a home purchased with a mortgage loan rate lock.
Source: (Shaylyn / Unsplash)

The pros and cons of a mortgage rate lock

Now that you’ve seen the mechanics of a rate lock and what it means for a typical loan, let’s examine pros and cons.

Advantages of a mortgage rate lock:

  • You could save substantial money if rates go up while you’re waiting to close
  • You’ll have peace of mind from knowing what your rate and payments will be
  • It protects you from possibly having to come up with a larger down payment if rates go up

Disadvantages of a mortgage rate lock:

  • It may cost you some money if the lender charges a rate lock fee
  • If you do pay for a rate lock and rates stay the same, the only thing you’ll have gotten in return is peace of mind
  • If rates go down and you can’t or don’t float down, you could end up with a higher rate than what is otherwise available or find yourself dealing with the delays of changing lenders.

All things considered, a rate lock is generally considered a useful risk management tool and an important benefit for borrowers.

A mortgage loan is the biggest financial transaction many borrowers will ever make, and the interest rate is a major variable. Market rates aren’t under anyone’s control, but a rate lock gives a borrower a tried-and-true, generally cost-effective way to manage the rates on his or her own loan.

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