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Rate locks
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What is a Rate Lock?

Locking an interest rate essentially means your lender is reserving your loan amount at a particular interest rate with a specific number of points for a certain period of time. Rate Locks are also known as "Lock-ins" or a "Rate Commitment". There are typically four very important elements to a Rate Lock.

  1. The Interest Rate
  2. The Points associated with the Interest Rate – these may include both origination and discount points.
  3. Lock Period or the Expiration Date of the Rate Lock
  4. The Loan Product associated with the rate lock. (i.e. 30 year fixed, 15 year fixed)

When requesting a Rate Lock or confirming the terms of a Rate Lock it is essential that all of the above 4 elements are covered.

The Interest Rate is the actual cost of the financing expressed as an annual percentage of the outstanding principal balance of the loan. The Interest Rate is usually the most obvious component of a Rate Lock that the customer will focus on.

The Points are expressed as a percentage of the loan amount, with 1 point equal to 1 percent of the loan amount. Lenders will typically charge a certain number of Points at a particular interest rate which can range anywhere from 0.000 to many. Some lenders also offer "rebate points" or "negative points"which can be used to defer closing costs. It is important that the number of Points associated with your Interest Rate have been defined, otherwise, the total cost of the financing will not be determined.

Rate locks typically expire in 15 day increments. Usually the longer the rate lock period, the higher the number of points associated with the interest rate. When buying a home, it is important the Expiration Date extends up to or beyond the scheduled closing or settlement date. When refinancing, the length of the Rate Lock must be long enough for the lender to process your application. Always ask the lender how long it is taking for the typical loan application to be processed. It may be wise to request additional time on the Lock Period if you are concerned about losing your interest rate due to slow processing times.

The Loan Product such as a 30 Year Fixed, 15 Year Fixed, 1 Year ARM, etc is also an essential element to the Rate Lock. Typically shorter term fixed rates will have lower interest rates with the same number of Points, but the monthly payment will still be higher because the loan is repaid more rapidly. Also, short term adjustable rate mortgages (ARMs) such as a 1 Year ARM, will typically have a lower initial interest rate than a 30 Year Fixed, but are more volatile and likely to increase in Interest Rate in the future. Therefore, the Loan Product must be clearly defined when requesting or confirming a Rate Lock.

Can I request a Rate Lock in writing?

Verbal rate locks my be common with some lenders but are obviously hard to prove in the event of a dispute. CompareInterestRates.Com suggests that borrowers always request a Rate Lock in writing. Financing a home is typically the single biggest financial transaction that an individual or family will make, and as such, it is important that the terms of that transaction be defined in writing. Each of the 4 above elements should be clearly indicated on any Rate Lock confirmation.

What is the difference between a Rate Lock
and Loan Approval?

A Rate Lock is not the same thing as a commitment or loan approval. It does not mean that the lender has approved your loan. A separate approval letter or commitment letter must be obtained after your application has been processed. Ideally the 2 events will be connected. If your lender requires loan approval before allowing a Rate Lock, then you should be able to obtain both a Rate Lock Confirmation and a Loan Approval letter in writing. If your Rate Lock occurred at the time of application, there is still the possibility that your loan application could be declined even though you have locked your interest rate.

When can one lock an interest rate?

Each lender has its own policy on Rate Locks. Some lenders allow rate locks at the time of application, some after the loan has been approved, some only allow rates to be locked 5 days prior to closing. Some lenders may even require the receipt or an application or rate lock fee before they will execute a rate lock.

Can I get a better interest rate than the day I locked?

Most lender’s policies regarding Rate Locks probably do not allow for a lower interest rate, even if market interest rates fall during your Rate Lock Period. The reason is simple, most lenders make a financial commitment based on your Rate Lock request by using some sort of financial hedge to guarantee they will be able to honor your Rate Lock at the time of closing. Just as you would expect the lender to honor their commitment even if market interest rates were to rise during the Rate Lock Period, the lender is expecting you to do the same even if interest rates fall slightly.

The exception to this is an official "float down" policy or procedure. Many lenders actually offer official programs where one can lower his or her interest rate during the course of the Lock Period. There may be an additional fee, a slightly higher initial interest rate, or specific market conditions required to participate in a "float down" program. The essential element again, is to get the details and procedures of a "float down" program in writing.

When should I lock my interest rate?

The typical reasons one would want to execute a Rate Lock are:

  1. to fix the cost of the financing.
  2. to insure the legitimacy of a lender’s interest rate quotes.
  3. In the case of a high debt/income ratio – one may need to make sure interest rates do not rise above a certain level in order to assure qualification for the loan.
  4. In the case of a refinance designed to lower one’s interest rates – one would not want interest rates to rise above the level where it makes financial sense to refinance.

There is a certain element of gambling involved in not locking ones interest rate. No one can look into the future and predict future interest rates with certainty. If you are risk averse then it may be wise to lock your interest rate. If you can tolerate a rise in interest rates, but would be thrilled with a lower rate then today’s market interest rates, you may be a candidate for floating your rate.