Mortgage Rate Locks: How They Work

When considering a mortgage rate lock-in, negotiate the terms and time period you need.

A mortgage rate lock (also called a lock-in) is a lender's promise to hold a certain interest rate at a certain number of points for you, usually for a specified period of time. It's meant to cover you for the time period while your loan application is being processed and you're preparing for the closing on the house. 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. It's a great way to protect yourself from rising interest rates while your loan is processed.

Why Get a Mortgage Rate Lock?

Whether buying a house or refinancing, people who don't use a rate lock are at the mercy of mortgage market while it ebbs and flows as the loan is being processed. That means that a 5.5%  rate when you begin the loan application process may rise to 6% by the closing.

Higher interest rates can also increase other loan costs. For example, it might mean:

• you must pay more points, or
• you have to put more cash down. (This might occur because higher interest rates mean higher monthly payments. The lender may want more cash down in order to keep your monthly payments in line with what you can afford or what the lender will allow.)

If you're refinancing with the purpose of staving off foreclosure, and rates increase, you could lose your home if the lender won't approve you for a higher rate. (In a refinance when foreclosure is not an issue, you have options to save the deal in case rates go up take out less cash or wait for rates to fall.)

What If Interest Rates Fall?

If interest rates fall during the lock period, you can't take advantage of the lower rate unless you:

• have included a "float down" provision in the original lock and advise the lender that you want to take advantage of it, or
• rewrite the rate lock at additional cost.

When you include a float down option in your rate lock, the lender must give you the locked-in rate if interest rates go up before closing while, if rates go down, you have the right to lock again at a lower rate. Because this increases the lender's risk, the price of a float down is higher than the price of a lock without a float down. (For more on lock costs, see "Shopping For a Mortgage Rate Lock," below.)

The Mortgage Rate Lock Contract

Because there are many variations on rate lock provisions, be sure the language of the lock contract gives you the options and time period that work best for you. Then get the agreement in writing it's extremely difficult to enforce a verbal agreement. The agreement should include all of the details, such as:

• the terms you've locked in, such as interest rate, points, and other costs
• the lock's effective date
• the lock cost
• the lock's expiration date and time, and
• any post-lock options.

When negotiating terms, here are some things to consider:

When to lock. Lock the rate in as soon as you see the rate you want or when you first apply for the mortgage so that your rate is locked as you spend time getting the application approved. That's particularly important if you barely qualify at today's rates and an increase would push buying right out of your reach.

You can also choose to set the lock upon approval of the loan. This might make sense in markets where the processing of loan applications is prolonged due to heavy demand for housing, but interest rates are trending down.

How long should the lock last? Before choosing a lock-in period, determine the average time for loan processing in your market. Ask your lender to estimate the time necessary to process your loan and verify the information with other realty and mortgage professionals. Locks average 30 days, but can range from 15 to 60 days. Longer is usually better. If the loan doesn't close on time, lenders can extend your lock for free, charge more for the extension, or charge an additional percentage of the loan amount.

Shopping for a Mortgage Rate Lock

Locks cost money. Shop around for both the best lock-contract terms and the lowest, most fairly calculated cost, which vary from lender to lender. Some lenders want up-front lock fees. Others take them at settlement. There are nonrefundable fees, flat fees, and fees based on a percentage of the mortgage, among other variations.

While shopping, verify that the rate lock is from the bank, mortgage lender, credit union, or other entity actually writing the loan not a broker, loan officer, or go-between. A broker can obtain a rate lock from the lender, but he or she can't actually write the lock.

Final Considerations

Once you lock in a rate, if you haven't already, quickly submit the application and other required documents. You should have previously checked your credit report and prepared evidence of your income, employment, debts, assets, and other relevant financial information. Stay in close contact with the lender (or broker) to be sure that the application is progressing quickly enough.

Pay attention to the deadlines. The benefits of the lock are good for only as long as the term of the rate lock. If you fail to complete your home purchase or don't refinance before the clock runs out, and interest rates rise, you'll have to pay the increased rate, along with any other increased costs.

If you have a float down provision, keep your eye on the market. It's your job to alert the lender that you want to take advantage of falling rates.

The Federal Reserve's A Consumer's Guide to Mortgage Lock-Ins offers extensive information about mortgage rate locks. Some states have specific rules that lenders must follow when granting mortgage rate locks. To learn about such rules in your state, if any, contact the state agency that regulates the mortgage industry.

To learn more about the ins and outs of buying a home, get Nolo's Essential Guide to Buying Your First Home, by Ilona Bray, Alayna Schroeder, and Marcia Stewart (Nolo).