With mortgage interest rates beginning to fluctuate and inch slowly upward, many home buyers are seeking rate locks from their lender as a hedge against higher rates at closing time. While a typical rate lock is 30 days or less from the time of signing an agreement, more and more buyers are looking for rate locks which span several months or even up to a year.
What is a rate lock?
A rate lock is a protection against changes in the mortgage interest rate between the time the purchase agreement is made and the time when the property deal is closed. When a deal is accepted between a home buyer, seller and lending institution, the bank will quote a mortgage interest rate for the particular type of loan the buyer is receiving. As a normal course of business, the lender may offer a rate lock of 15 or 30 days, or, in some cases, even fewer days.
Because the closing process on real estate can be complicated and sometimes lengthy, many buyers are now asking banks for longer guarantees on giving the buyer the original quoted rate. Banks are often willing to accommodate such a request and put it into writing, but, like most things in life, the option comes at a price.
The longer the duration of the rate lock, the more the bank will charge as a fee for the extension. Fees can also be influenced by a buyer’s credit worthiness, how much they are paying as a down payment and whether or not a deposit has been made prior to closing. The better a prospective buyer’s credit score, the higher the down payment and income-to-debt ratio, the better the terms are likely to be.
What protects the buyer protects the bank
Something that is important to understand about a rate lock is that it works both ways: if the index interest rate goes down while the rate lock is in effect, the buyer may be stuck with the higher rate. The exception is if the agreement with the lender includes what is called a float down provision, which allows the buyer to take advantage of the lower rate at the time of closing. Because the bank will not want to shoulder the bulk of the risk, such a provision can come at an additional cost up front to the buyer.
Fees associated with rate locks are usually calculated as percentage points—simply called “points”—of the total value of the loan. Points may be as little as one-eighth of a point for a short term extension but can run much higher for longer extensions and for using a float down option, which can add up to a significant cost to consider.
If the cost of paying the points is steep, the buyer needs to calculate the difference between the fee and the amount saved in interest over the course of the loan. A lower interest rate is likely going to cost less over the long term, but if the buyer only plans on staying in the home for a few years, it might make more sense to pay the points. Even if a buyer plans to remain in the home over the long term, they may wish to refinance along the way, making the costs of a rate lock less attractive.
Fees for rate locks can be charged by the lender in the form of cash up front or at closing time. With home buyers trending toward longer rate locks, banks will be sure to enact policies that work in their favor, so buyers must make decisions. It is important the buyer understands all of the terms of the rate lock to avoid any surprises.
Current figures for the best mortgage rates can be found on our mortgage page.
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