FM Lending: Advice On Locking Interest Rates

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The following post is written by Hugh Page of our FM Lending. Thanks, Hugh!

To Lock or Not to Lock – That is the Question

Once a consumer talks with a lender, and finalizes the type of loan they will obtain, their next question is often, “Should I lock in my interest rate?”  Some folks have no idea they even need to lock in their rate.  The bottom line is that in today’s mortgage market driven primarily by investor pricing in the Secondary Market, locking in your interest rate with the lender is an important part of the process.

So what does it all mean and what should I know about the process?

When locking in an interest rate you are really locking in two things; the interest rate, and the associated “origination charges” for that given interest rate.  It is a tradeoff.  Every loan is priced with a 1% loan origination fee and you are either paying it as part of your closing costs or the cost of the fee is absorbed by the lender in exchange for a slightly higher interest rate.  A rule of thumb that is commonly used is that for each 1% in origination charges that you pay your interest rate declines by .25%.  This is not a hard and fast rule, however, so discuss the differences carefully with your mortgage professional.   Pricing can be funny from one day to the next.

Lock periods can be as little as 10 days or as long as 180 days. Locks of less than 30 days are usually for loans that are already approved by the lender with most if not all conditions cleared for closing.  Long term locks (>90 days) usually require an “Upfront” fee that is non-reimbursable if you walk away from the lock. Typically the longer your lock in period the worse your interest rate/origination charges combination will be and vice versa.  Shorter lock periods have better “pricing”.  The difference in cost or origination charges at a given rate for a 15-day lock and a 180-day lock can be quite significant and frequently as much as 1.5 percent of the loan amount.  The standard maximum lock period where no additional fees must be paid is 60 days.   The important thing to make sure of is that your lock in period will take you past your closing date.

A common question from consumers is –

“If I lock in my interest rate, and rates fall between now and my closing date, can I get the lower rate/better pricing?” 

In harsh reality a rate lock is a one way deal. It protects only the borrower. When rates drop, borrowers want a better deal. This is where the daily updates of internet sites have created havoc in our industry. Your loan officer is in the middle of all this. Borrowers want the best rates and lenders do not want to allow borrowers to walk away from their agreed upon rate locks.   Some lenders say they have “float-down” policy allowing a onetime drop in rate if the market improves during your lock period. Usually, however, there is no free lunch.  Your lender may be able to renegotiate a rate with the investor who has locked the loan; however, it usually costs a fee to do it. So, pricing has to improve greatly to absorb this fee as federal law now prohibits lenders from passing this fee on to you.

A couple of other items about interest rate locks:

1)      You can’t lock in an interest rate until you are under contract for the purchase of a property.

2)     An interest rate lock is not an approval of your loan. It only guarantees the interest rate and origination charges you will receive if the loan is approved.

Some people like to play the game of “floating” where you wait to lock in your interest rate and try and time the market when pricing improves.  This is a dangerous game to play.  If you suddenly run in to a rising rate market which can turn in a matter of minutes during the trading day it may end up costing you a lot of money.  A better tactic may be to lock in and “protect” your interest rate as soon you are under contract and you are comfortable with the payment and closing costs associated with that interest rate.  The old cliché is true.  Better to be safe than sorry!

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