Published October 04, 2012
Whether to lock or float a mortgage rate is a crucial question for borrowers. And it's not easy to answer. Here's a look at what to consider when deciding whether to lock or float a mortgage rate.
All interest rates are subject to risk due to market fluctuations. If a rate is locked, that risk is transferred from the borrower to the lender. If mortgage rates then rise, the borrower still gets the promised lower rate. However, if rates drop, the benefit swings to the lender.
Some borrowers lock a mortgage rate as soon as possible. That's a safe position because locking eliminates the risk of ending up with a higher rate, explains Peter Thompson, a senior loan officer at Prospect Mortgage in Naperville, Ill.
The rationale is that capturing a slight improvement in rates won't make much of a difference in the borrower's total interest expense.
"Some people say, 'These rates are phenomenal, and even if they get a little bit better, they are so good right now that it really doesn't matter,'" Thompson says. "They'd rather take the risk off the table."
A better rate might add up to substantial savings over 15 or 30 years of payments. However, as Thompson notes, most people don't keep the same mortgage that long, so the actual sum is less significant.
If the borrower allows the rate to float, a rate rise will benefit the lender, and a drop will help the borrower. That's why some borrowers prefer to float "just in case it gets a bit better," Thompson explains.
The idea is that rates probably won't spike, so even if the borrower loses the gamble, the higher cost won't be that significant. Maybe so. And maybe not.
Floating is riskier for homebuyers who need a new loan to close their home purchase than it is for homeowners who can choose to refinance or not depending on whether the rate is advantageous. Homeowners who opt to float can simply abandon the new loan if rates rise.
The decision to lock or float should be about risk. Yet borrowers oftentimes allow their ego and quest for bragging rights to wriggle into the equation.
"They want to be able to tell people they have the lowest rate. It's kind of funny, but that is a factor," Thompson says.
The best of all possible worlds would be to lock and float simultaneously, sticking with the lock if rates rise and breaking it if rates drop.
Thompson says a borrower might be able to "renegotiate" a rate after it's locked, but that's not a standard practice or guarantee.
Borrowers should be aware that lenders' quoted rates often include "padding" in the lender's favor. As a result, an option to float down a locked rate typically is more about market conditions than superior negotiation skills.
Negotiating a lower rate upfront typically isn't an option. As Greg Cook, a loan consultant at Golden Empire Mortgage in Temecula, Calif., explains, lenders "cannot individually negotiate rates." To do so would give some borrowers special deals not offered to others and potentially expose the lender to allegations of discriminatory practices.
The bottom line is that borrowers have to assess how much risk they can tolerate.
"The whole thing comes down to (the reality) that nobody knows what direction rates are going to go," Thompson says. "For most people, it's better to lock and forget about it because, yes, you might feel good if you get that lower rate, but you will feel a lot worse if it goes the wrong way."