The rate lock might be the most complicated issue mortgage borrowers need to understand. Here, five questions and answers demystify how a rate lock works.
What is a rate lock?
A rate lock is a guarantee that the lender will offer the borrower a specific combination of interest rate and points, according to Greg Cook, a loan consultant at Golden Empire Mortgage in Temecula, Calif. A point is a fee or rebate equal to 1% of the loan amount.
Also essential to a rate lock is a time period, typically 10, 15, 30, 45 or 60 days.
A rate lock protects the borrower from rate fluctuations for the duration of the lock period. If market rates rise after the rate is locked, the borrower will still get the lower rate, to the lender's detriment. But there's a downside: If rates fall after the rate is locked, the borrower might not be able to take advantage of that opportunity.
When can a rate be locked?
During the housing boom, some lenders allowed borrowers to lock while they were house hunting. Today, buyers typically must wait until a seller has accepted their purchase offer for a specific property.
Other information is also necessary to lock because rates offered to an individual borrower depend on the borrower's credit score, the loan-to-value ratio, the property type, locality and other factors in addition to market rates.
"Until I have all the pieces to the puzzle," Cook says, "I can't accurately quote what their rate and cost will be."
How long can a rate be floated?
In theory, a mortgage rate could be floated until the transaction closes. But that's not practical in the real world, explains Peter Thompson, a senior loan officer at Prospect Mortgage in Naperville, Ill.
Instead, the rate must be locked at least a few days or more likely a week before closing to allow time for the lender to prepare disclosures and loan documents. This paperwork is known as the closing package.
"Typically, you want a week between locking and closing," Thompson says. "You can't really (float until) the day before because we have to do the closing package."
How much does a rate lock cost?
Borrowers are often told there's no charge for a rate lock. That's true in the sense that the rate lock isn't associated with a fee. But a rate lock isn't free. Rather, a longer rate lock typically involves a higher interest rate, which is more expensive for the borrower. The interest rate, or "pricing," difference between a 15-day rate lock and 60-day rate lock might be as little as one-eighth or as much as one-half of a percentage point, Thompson explains.
"The shorter the term that it's locked, the more risk (the borrower) is taking on," he says. "But they should be getting a better price."
What happens if the rate lock expires before closing?
The lender might offer to extend the rate lock. If not, that combination of rate and points might no longer be available.
"If you go beyond the lock period," Thompson says, "you'll have to get an extension, or if an extension isn't possible, you'll end up paying the market rate, and it could be higher."
This back-end risk is a good argument for a longer rate lock, especially if the transaction involves a short sale or a brand-new home that's under construction.
"The big thing is having a firm knowledge of when you'll be able to close," Thompson says.