What is a rate lock and how does it work?
When you're looking for a mortgage, you're likely to shop among lenders for the most favorable interest rate, and the lowest points and other up-front charges. When you find the most favorable terms and the lender that you want, you'll apply to that lender. But when you get to settlement, will you actually receive the terms you applied or bargained for? Or will you find that the rate has changed-and that your costs have gone up?
Lock-ins on rates and points might offer you a way to ensure that what you shop for is what you get. This section explains what these arrangements mean.
In most cases, the terms you are quoted when you shop among lenders only represent the terms available to borrowers settling their loan agreement at the time of the quote. The quoted terms may not be the terms available to you at settlement weeks or even months later. Therefore, you should not rely on the terms quoted to you when shopping for a loan unless a lender is willing to lock your interest rate.
What Is a Rate Lock?
A rate lock, also called a lock in or rate commitment, is a lender's promise to hold a certain interest rate and a certain number of points for you, usually for a specified period of time, while your loan application is processed. (Points are additional charges imposed by the lender that are usually prepaid by the consumer at settlement but can sometimes be financed by adding them to the mortgage amount. One point equals one percent of the loan amount.) Depending upon the lender, you may be able to lock in the interest rate and number of points that you will be charged when you file your application, during processing of the loan, when the loan is approved, or later.
A lock-in that is given when you apply for a loan may be useful because it's likely to take at least two weeks or longer to prepare, document, and evaluate your loan application. During that time, the cost of mortgages may change. But if your interest rate and points are locked in, you should be protected against increases while your application is processed. This protection could affect whether you can afford the mortgage. However, a locked-in rate could also prevent you from taking advantage of price decreases, unless your lender is willing to lock in a lower rate that becomes available during this period.
It is important to recognize that a lock-in is not the same as a loan commitment, although some loan commitments may contain a lock-in. A loan commitment is the lender's promise to make you a loan in a specific amount at some future time. Generally, you will receive the lender's commitment only after your loan application has been approved. This commitment usually will state the loan terms that have been approved (including loan amount), how long the commitment is valid, and the lenders conditions for making the loan such as receipt of a satisfactory title insurance policy protecting the lender.
It is important to get the lender's commitment to lock in your interest rate in writing. Oral agreements can be very difficult to prove in the event of a dispute.
Lenders may charge you a fee for locking in the rate of interest and number of points for your mortgage. Some lenders may charge you a fee up-front, and may not refund it if you withdraw your application, if your credit is denied, or if you do not close the loan. Others might charge the fee at settlement. The fee might be a flat fee, a percentage of the mortgage amount, or a fraction of a percentage point added to the rate you lock in. The amount of the fee and how it is charged will vary among lenders and may depend on the length of the lock-in period.
Lenders may offer different options in establishing the interest rate and points that you will be charged, such as:
1) Locked-In Interest Rate-Locked-In Points
Under this option, the lender lets you lock in both the interest rate and points quoted to you. This option may be considered to be a true lock-in
because your mortgage terms should not increase above the interest rate and points that you've agreed upon even if market conditions change.
2) Locked-In Interest Rate-Floating Points
Under this option, the lender lets you lock in the interest rate, while permitting or requiring the points to rise and fall (float) with changes in market conditions. If market interest rates drop during the lock-in period, the points may also fall. If they rise, the points may increase.
Even if you float your points, your lender may allow you to lock-in the points at some time before settlement at whatever level is then current. (For instance, say you've locked in a 10 1/2 percent interest rate, but not the 3 points that went with that rate. A month later, the market interest rate remains the same, but the points the lender charges for that rate have dropped to 2 1/2. With your lender's agreement, you could then lock in the lower 2 1/2 points.)
If you float your points and market interest rates increase by the time of settlement, the lender may charge a greater number of points for a loan at the rate you've locked in. In this case, the benefit you might have had by locking in your rate may be lost because you'll have to pay more in upfront costs.
3) Floating Interest Rate-Floating Points
Under this option, the lender lets you lock in the interest rate and the points at some time after application but before settlement. If you think that rates will remain level or even go down, you may want to wait on locking in a particular rate and points. If rates go up, you should expect to be charged the higher rate.
Because practices vary, you may want to ask your lender whether there are other options available to you.
How Long Are Rate Locks Valid?
What Happens if the Rate Lock Period Expires?
If you don't settle within the lock-in period, you might lose the interest rate and the number of points you had locked in. This could happen if there are delays in processing whether they are caused by you, others involved in the settlement process, or the lender. For example, your loan approval could be delayed if the lender has to wait for any documents from you or from others such as employers, appraisers, termite inspectors, builders, and individuals selling the home. On occasion, lenders are themselves the cause of processing delays, particularly when loan demand is heavy. This sometimes happens when interest rates fall suddenly.
When you're ready to settle on your loan, you'll want to get the loan terms that you've locked in. To increase that likelihood, it is important to learn as much as you can about what the lender is promising you before you apply for a loan. Ask for the following information when you shop for a loan:
- Does the lender offer a lock-in of the interest rate and points?
- When will the lender let you lock in the interest rate and points? When you apply? When the loan is approved?
- Will the lock-in be in writing? If the lock-in is not in writing, you will have no record of the lender's agreement with you in case of a dispute.
- Does the lender charge a fee to lock in your interest rate? Does the fee increase for longer lock-in periods? If so, how much?
- If you have locked in a rate, and the lender's rate drops, can you lock in at the lower rate? Does the lender charge you an additional fee to lock in the lower rate?
- Can you float your interest rate and points for now, and lock them in later?
- What rate will be charged if the lock-in expires before settlement-the rate in effect when the lock-in expires?
- If you don't settle within the lock-in period, will the lender refund some or all of your application or lock-in fees if you decide to cancel the loan application?
- If your lock-in expires and you want to get another lock-in at the rate in effect at the time of the expiration, will the lender charge an additional fee for the second lock-in