Unlocking the Rate Lock Mystery
Everyone who has financed a home with a mortgage, either for a purchase or refinance, has probably struggled at some point during that transaction with the dilemma of locking or floating the interest rate. This critical decision does one of two things:
- Commits both the borrower and the lender to a specific interest rate for a set period of time. This “for better/for worse” proposition means that if rates move up or down, the commitment cannot be broken. This action is known as “locking” a rate.
- Leaves the interest rate open to future market fluctuation, again for better or for worse, until the rate is locked. This is known as “floating” the rate.
Because I am no better a forecaster of market events than anybody else (although I would argue I am more informed about forces that can influence mortgage rates --- after all, that is part of my job), the scope of this article will not be to advise you on what to do with your loan in process. Rather, I hope to provide a primer on the mechanics of rate locks, some insight into important facts to consider and also some perspective on how to make an informed decision and perhaps sleep a little easier knowing that you have done the best you can considering the things you do control. Let’s get started on the lock process itself.
What Is a Rate Lock?
Simply, a lock is a transfer of risk from you to the lender. “Wait, what? If I’m the one making the hard decision, aren’t I taking all the risk?” Not exactly --- there is equal risk on both sides of the transaction. When you are floating your rate, you are at risk that interest rates could move higher and this can have real consequences for you; a higher monthly payment, risk of no longer qualifying, etc. But when a lender makes a commitment to lend money at a certain rate, they must also do so regardless of what happens day-to-day on the financial markets. If rates drop one-half percent during the time you are in process, for example, the lender now has a very high risk that the lock could be broken. It’s not that the lender doesn’t want you to get a great rate, it’s that the lender has already secured funds to deliver your lock on the banking level.
In short, rate locks are commitments. And breaking commitments on either the consumer or bank side has consequences. You may have noticed that longer lock periods such as 45-day or 60-day locks have pricing that is relatively worse to the consumer than the “standard,” 30-day lock. The reason for this is simple. The more time included in the lock, the greater opportunity for market fluctuation and the less appealing the price to the consumer.
Should I Lock My Rate?
Since nobody can predict what will happen with rates, is it even worth it to deliberate over locking or floating? This is a great question and perhaps the best way to address it is to assess the timing of the transaction itself. Let’s say you are buying a home and you’ve just entered into a contract that is due to close in 30 days --- not uncommon here in California. No matter who you are and what you’re trying to accomplish there is an 800-lb. gorilla in the lending room these days and it’s called regulation. Regulation requires that your lender adhere to certain timing on disclosures and at the end of your process you will have a set of loan documents drawn and sent to escrow for your signing. You can and should plan to have between 7 and 10 calendar days of your 30 days total consumed by regulatory requirements. That is, your lock decision MUST come before these last seven or ten days. As a result, you may be left with two business weeks’ worth of days at the beginning and middle of your transaction on which to lock your rate.
Your lender can help you assess what market-moving reports and financial events might occur during that time. Perhaps it is a good thing that you do not have a limitless amount of time to wring your hands about when to lock. We find that when that happens, consumers will often overthink the process and try to outsmart the market and like with stock investing, market timing usually leads to poor results. Conversely, when refinancing a home, the element of time is more within the borrower’s control. In these cases, the consequences of a wrong float decision can be mitigated if the market “comes back,” but we have seen time and again on this side of the desk that resolute choices on locking, once a target rate has been established and met, tend to be the best calls. “Bottom fishing” or “playing the market” for an ever lower rate tends to backfire and worse, not having a target rate can engender stress and “analysis paralysis.” As they say, “If you don’t have a goal, you can be sure that you'll hit it.”
Once you lock your rate, you can cross one other decision and action off of your list, and many borrowers find this alone to be a big relief. After all, there will be occasions once your loan is closed where rates will move both higher and lower. When they move up, you will be glad you are locked, and when they move down you can always consider refinancing if the analysis bears out financial efficacy. The rate lock process does not ever need to be approached with dread, however. By assessing the time requirements of your transaction, determining a realistic target rate at which you will feel satisfied, understanding market forces that can play upon your rate for better and worse and, most importantly, by taking resolute action when your target rate arrives, you will fare better than most. Having watched thousands wrestle with the question, “should I lock my rate?” I can tell you firsthand that Theodore Roosevelt may just have said it best, though he was certainly not discussing a rate lock choice: “In any moment of decision the best thing you can do is the right thing, the next best thing is the wrong thing, and the worst thing is nothing.”
Lock 'em and doc 'em,
LendUSA, LLC dba RPM Mortgage NMLS #1938 Licensed by the Department of Business Oversight under the California Residential Mortgage Lending Act.