Rate Locks - Why do longer ones cost more?

Rate Locks – Why do longer ones cost more?

We’ve all heard the saying that “time is money.” Some people may need no more explanation that that. If you’re a little more inquisitive or want to be able to better strategize the optimal time to lock your interest rate, read on below:

 It’s never as simple as it seems – and it’s not always the same as there are different types of lenders and different types of loans. Portfolio lenders are lending based on the rate they pay on deposit accounts. That can vary at any given time as yields vary for checking, savings or CD’s. Then there are loans that will be securitized with either Fannie Mae or Freddie Mac, the private securitization market and a host of other niche markets or programs most which float with the market.

OK, but that still doesn’t answer the question – Correct, and that’s because it’s first more important to understand what type of loan you are considering. Why? Because, this provides more insight into choosing to pay or avoid the premium that may be attached to a longer rate lock. In other words, it’s possible for one loan type to have less risk or volatility in the rate from day to day or week to week than for the alternatives. If that’s the case, it can or perhaps should influence your decision making.

Finally, the answer!– If you lock your loan for 30 days, there is less risk to the lender of rate changes between your lock and the closing. Less risk to the lender might mean a better price or rate for you. A longer lock means that the lender is shouldering the risk for a longer period and by the time your loan closes, your rate could be below the market and worth less from the lender or a loan buyer’s point of view. To protect themselves, a lender must purchase a “hedge” and that costs money. So as you can see, the cost of providing you with security is built into the price and can equal a more expensive lock. The easy way to understand this is that it’s insurance, the longer the protection lasts, the more you will likely pay for it.

Risk is not a One-Way Street – There is risk to borrowers too. You could use a long lock and never end up having needed it. Worse, you could pay a premium for a long lock and rates could fall. Still, it’s best to stick with thinking of this as insurance because that’s really what it is. The market will do what it will do and regardless of that, it’s the insurance that you pay for rather that the rate itself. To be clear, this is like insuring your care, you don’t hope to get in an accident, but the coverage is there if you do. If you didn’t crash, you’re lucky, yet not so much that you also get your money back. If that were the case, insurance would cost so much that no could afford it.

How long do you need to lock for? – When getting a quote for an interest rate make sure to ask how many days that rate is good for if you were to lock in today. Most loan officers will quote rates on a 30-day up to a 60-day lock depending on if you’re purchasing or refinancing. If you decide you want to lock you want to insure the lock will cover the time needed to close your loan. If getting a purchase you can usually follow the closing date on the purchase contract, but it is also a good idea to give yourself some extra room in case of any delays in the loan process. Special programs like 203K, escrow holdbacks and State grant programs such as Colorado’s CHFA will require more time to close then the typical loan. Ask your loan officer for advice and to let you know what your options are.

At the end of the day, the rate has to be locked in at some point. It’s good practice to decide if you will be most comfortable knowing that it is safely locked in or if you are comfortable “floating” the rate until a shorter lock can be used. Either way, if you have any questions we’re here to help and you can reach out anytime for assistance.