Mortgage FAQ

7. What is a rate lock?

You cannot close a mortgage loan without first locking in an interest rate. A rate lock has four components:

1. Loan program
2. Interest rate
3. Points
4. Length of the lock

The longer the length of the rate lock is, the higher either the points or the interest rate will be. This is because a longer rate lock poses a greater risk for the lender offering that lock.

Imagine that on March 2nd you locked in a 30-year fixed loan at 8% with 2 points for 15 days. This lock will expire on March 17th (if March 17th is a holiday then the lock would most likely be extended to the first working day after the 17th). The lender must disburse funds by March 17th, or your rate lock expires, and rendering your original rate-lock commitment invalid.

The same lock might cost 2.25 points for a 30-day lock or 2.5 points for a 60-day lock. If you need to extend to a longer lock but do not want to pay higher points, you could opt to pay a higher rate instead.

Once a lock expires, lenders will usually let you re-lock at the higher of the prevailing market rates/points, or sometimes the originally locked rates/points. In most cases you cannot get a lower rate if rates drop.

Prior to the rate lock expiration date, the lender may choose to allow you to negotiate a rate lock extension at the original rate/points. However, there may be an additional fee for this extension.

Lenders are taking a risk by letting you lock in advance, so they stand to lose money if your lock expires. If rates go up, they are forced to give you the original, lower, rate at which you locked. Lenders will often try to protect themselves against rate fluctuations by hedging.

Some lenders do offer free float-downs, letting you lock the rate initially and giving you the better rate if rates drop while your loan is in process. However, the free float-down is costly for the lender and you end up paying for this option indirectly, in your rate. The lender has to build the price of the float-down option into the rate, so the float-down rate may be 0.125% to 0.25% higher than the prevailing current market rate.

What happens if rates drop after you lock?

Because it is expensive for lender to lock in interest rates, most will not budge unless rates drop substantially (3/8% or more). If lenders let borrowers improve their rate every time rates improved, they would spend a lot of time relocking interest rates, since rates fluctuate daily. Also, this option would have to be factored into their rates, and borrowers would wind up paying a higher rate anyway. If rates drop, you could switch to a different lender. If you choose this option, know that you will have to start the loan process over from the beginning. However, if you used a mortgage broker to get your loan, they will probably be able to move your loan package, including your application, to the new lender offering lower rates. Inform your original lender that you are aware that rates have dropped, and you may find that your lender would rather work with you than lose you to a competitor. It is worth trying before you start the application process with a different lender.

Lock-and-shop programs

Usually lenders will only allow you to lock in an interest rate on one specific property. This means if you are shopping for a home you cannot lock in an interest rate until you have signed a purchase contract for that specific property. Some lenders may offer a lock-and-shop program. A lock-and-shop lets you lock in a rate before you find the home, an attractive feature when rates are rising. This can be very useful for securing a lower rate; however, lock-and-shop rates are usually higher than the prevailing market rate. Also, there may be a non-refundable fee or deposit towards closing costs.

New-construction rate locks

Most lenders will offer long-term locks for new construction. Long-term locks come at a price; they tend to cost more and often require an up-front deposit. For example, a lender may offer a 180-day lock for 1 point over the cost of a 30-day lock and require that 0.5 points being paid up-front, as a non-refundable deposit. A benefit of long-term new-construction locks is that most offer a float-down, so if rates drop prior to closing, you can get the better rate.

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