Rate Locks And How They Work

Remember, rates change all the time, and it can be one or two months between the time you apply for a loan and when your sale closes... and rates can have jumped in that time.

A lock commits the lender to lend at a specified interest rate and points, provided the loan is closed within the specified "lock period." For example, a lender agrees to lock a 30-year fixed-rate mortgage of $200,000 at 7.5 percent and 1 point for 30 days. The lock lapses if the loan doesn't close within 30 days.

A lock imposes a cost on the lender, and the longer the lock period, the higher the cost. This cost is in the price quoted to borrowers. The lender who quotes 7.5 percent and 1 point for a 30-day lock, for example, might charge .875 points for a 15-day lock, and 1.125-1.25 points for a 60-day lock.

Some borrowers elect to "float" the rate, meaning not to lock it, as long as possible. If the market is stable, they expect to benefit from the declining lock price. They may also believe that market rates will decline.

It would be pretty silly for a home purchaser who barely qualifies at today's rate to risk a rate increase - if rates jump they may no longer qualify for the loan. But even if qualification is not an issue, floating past the point where you can change loan providers is risky if you have no way to monitor the market price on the day you finally lock.

If the market price on the day you lock is what the loan provider says it is, you are at his mercy. (Some will pad the price just because you have nowhere to go.) On a refinance, you can always change loan providers, so it's safer to delay the lock until shortly before closing.

Allowing the price to float on a purchase transaction is safe if you have a way to check the market price on the day you lock. If you originally shopped the lender's website and found your price there, you can check it again on the lock day. Otherwise, don't float, except in certain circumstances.

Borrowers who are refinancing can monitor the floating interest rate/points quoted to them by the broker against other market information, and if the quote appears out of line they can bail out - after all, you don't have to refinance, you just want to. Home buyers with a scheduled closing, however, eventually reach the point of no return where it's too late to start mortgage shopping all over again.

During a refinancing boom period, when loan processing takes longer, the point of no return might be 45 days rather than the 30 days that might be okay in a more normal market.

To protect yourself, just don't float past the point where you can bail out and shop elsewhere. Or, you should pin down the lender or broker on an objective procedure for determining the market interest rate. One simple and fair rule is that the market rate will be the rate that the lender is quoting to potential new customers on the same day.

If you lock only a few days before closing, your rate should be the lender's current float rate. If you lock 15 days before closing, your rate should be the lender's 15-day lock rate on that day. And so on.

One advantage of dealing with an individual lender or broker who is internet savy is that they can provide you with the data you need to monitor the rate they give you when you lock.