When you apply for a mortgage or decide to refinance, lenders present you with an interest rate based on current market conditions. However, these rates can fluctuate daily or even hourly. An interest rate lock is your tool to freeze that offered rate.
Here’s the process:
- Apply for a Loan: After submitting your mortgage application, you receive a loan offer detailing a specific interest rate.
- Request the Lock: Once you have a signed purchase agreement for a property, you can formally ask your lender to “lock” the rate.
- Receive a Written Agreement: Your lender must provide a written rate lock agreement. This document is essential as it specifies the locked interest rate, the duration of the lock (e.g., 45 days), and any related closing costs.
- Close Before Expiration: As long as you close on the loan before the lock expires, you are guaranteed that rate, regardless of whether market rates have increased.
How a Rate Lock Benefits You: A Real-World Example
Imagine you are purchasing a home for $400,000. Your lender offers a 30-year fixed-rate mortgage at 6.5%. With rates being volatile, you opt to lock in the 6.5% rate for 60 days.
A month later, due to economic shifts, the average mortgage rate jumps to 7%. Because of your rate lock, this market change doesn’t impact you. You proceed to close at the 6.5% rate. This half-percent difference can save you approximately $125 per month, adding up to over $45,000 in savings throughout the 30-year loan term.
Key Considerations Before Locking Your Rate
A rate lock is a powerful financial tool, but it’s important to understand its key components.
The Lock Period
Rate locks are temporary, typically lasting 30 to 60 days, which is generally sufficient time to close on a home purchase. For new construction, a longer lock of 6-12 months may be necessary and usually comes at a higher cost. If the lock expires before closing, you may be subject to the current, potentially higher, market rate. Lenders may offer a “lock extension,” but this often involves an additional fee.
The Cost of a Rate Lock
Some lenders may offer a “no-cost” rate lock for a standard period. However, this cost is often absorbed into the interest rate itself. Lenders might propose a slightly lower rate if you decide to “float” the rate, meaning you don’t lock it and let it move with the market. For longer lock periods, expect to pay an upfront fee, typically between 0.25% to 0.50% of the total loan amount.
The “Float-Down” Option
A float-down provision is a valuable feature that allows you to secure a lower rate if market rates decrease after you have locked. This option protects you from rate hikes while offering the potential to benefit from rate drops. It usually comes with an additional fee but can be a worthwhile investment in a fluctuating market.
Rate Lock vs. Floating Rate: Which Is Right for You?
Deciding whether to lock your rate or let it float depends on your risk tolerance and market outlook.
| Feature | Interest Rate Lock | Floating Rate |
|---|---|---|
| Certainty | High: Your interest rate is guaranteed for the lock period. | Low: Your rate can change at any time before closing. |
| Risk Level | Low: You are protected from increases in interest rates. | High: You are exposed to the risk of rates rising. |
| Potential Reward | Limited: You get the locked rate, even if market rates fall (unless you have a float-down option). | High: If rates decrease, your final interest rate will be lower. |
| Best For… | Borrowers who prefer budget certainty and anticipate that rates will go up. | Borrowers who are comfortable with risk and believe rates will fall before they close. |
Common Mistakes to Avoid
- Locking Too Soon: Locking a rate before you have a signed purchase contract could lead to the lock expiring before you are ready to close.
- Not Getting it in Writing: A verbal agreement is not a substitute for a formal, written rate lock agreement. Always review the document carefully.
- Altering Your Application: Significant changes to your loan application, such as a drop in your credit score or a change in the loan type, can void your rate lock.
- Ignoring the Float-Down Option: Always inquire about the availability and cost of a float-down option to understand all your choices upfront.
Ultimately, an interest rate lock is a strategy for managing risk and achieving financial peace of mind. By securing your rate, you eliminate a major variable, allowing you to concentrate on the successful completion of your home purchase or refinance.
Source:
- Consumer Financial Protection Bureau (CFPB). “What is a mortgage rate lock?”. Retrieved from https://www.consumerfinance.gov/ask-cfpb/what-is-a-mortgage-rate-lock-en-143/
