In last week’s post, I talked about where mortgage rates come from. This week, let’s talk about rate locks: what they are, how they work for borrowers (and lenders) and how borrowers can use their lock to manage risk.
And (shameless plug of the week) I’ll highlight the Guaranteed Rate Lock ‘N’ Roll program, which offers the option to lock in a rate while shopping for a home.
What is a rate lock?
A rate lock is a promise, by your lender, to close your loan at a specific interest rate and cost for a certain timeframe. With rates changing daily (and even intradaily), you set your loan terms, when you lock in your rate.
When can I lock?
In most instances (but not always), you are eligible to lock once you know two things:
- the address of the property you are buying
- your closing date
You’ll usually lock your rate once you have an accepted offer, but there are exceptions. Perhaps you are waiting for your old home to sell, for the seller to find a home to buy or don’t yet know of when construction on your new home will be completed. If the timeline for your transaction is uncertain, it may not be advisable to lock until things firm up.
Your rate lock will be good for a specific duration—25, 40 or 55 days is typical. Rate locks of 6 months or even a year exist, but generally only for a new home under construction. A shorter rate lock almost always costs less than a longer rate lock.
Lock while you shop with Lock ‘N’ Roll
What if you worried about rates going up while you shop for a home? On many of our most popular programs, Guaranteed Rate offers the option to lock your rate while you shop–to “Lock ‘N’ Roll”.
Apply for a conventional, FHA or VA loan and you can secure a fully-underwritten pre-approval and a lock your rate for 55, 70 or 85 days.
Can I “Float Down” to a better rate?
I like to think of a rate lock as akin to an insurance policy –, providing protection in the face of the uncertainty of the ever-changing interest rate market. Once locked, whether the interest rate market subsequently gets better or worse, your rate is set at the terms available the moment you locked.
That said, many of the programs we offer (including “Lock ‘n’ Roll”) have a “renegotiation” or “float-down” option. A true “float down” allows you to lock a rate and then drop to a lower interest rate if the market improves. These loans are rare, generally require a non-refundable deposit and only float down once, at a prescribed time.
More commonly, we can “renegotiate” a lock if rates drop significantly enough after locking. Renegotiating always carries a cost (0.25% of the loan amount is common), so the improvement has to be enough to come out ahead after paying the required fee.
Expiration and Extension
If your closing is delayed, most loans permit us to extend your rate lock before it expires. The cost varies based on the program. Fees of 0.02% of your loan amount per day or 0.125% of your loan amount for 7 days are examples of typical extension costs..
And although an expired lock can be re-locked, relocks are generally subject to worst-case pricing between the terms of the expired lock and current market rates and extension of fees may apply. It is almost always better to extend your lock, before it expires.
Behind the curtain
To lenders, rate locks represent a significant risk that must be managed carefully.
You’re shopping for a home, you get your offer accepted (yeay!), call us up and we lock in your rate. So long as your loan closes before the lock expires (usually 40 days), you no longer have to think about your rate changing.
But what about us? By promising you a specific rate, we’ve shouldered all of your interest rate risk. After your loan closes (as discussed in last week’s post), we are going to sell your loan on the secondary mortgage market. That’s how we get our money back to lend again.
But that sale isn’t going to happen for a month or two. And in the meantime, interest rates can (and will) keep changing. The price for which we can sell your loan varies with the bond market. We’re not in the (very risky) business of speculating on the interest rate market, so we need to manage the risk that bond market activity brings.
Hedging our bets
So how do lenders manage this risk? By “hedging”.
The rate lock promises we’ve made and the mortgages we’ve closed go up in value as rates fall and down in value as rates rise. So we protect ourselves by purchasing other investments that we know will change value in the opposite direction as rates change — going down in value as rates fall and up in value as rates rise.
Presto! We’ve now protected the underlying value of the mortgages we’ve yet to sell. Whether rates rise or fall, we’re okay (our losses in one place are offset our gains in another).
Check us out!
And of course, before taking about rates, finding the right loan option has to comes first. My team and I are here to help with that too… call or email any time.
We look forward to hearing from you!