To Lock or Not
One of the toughest decisions you will need to make during the loan process is weather to lock you interest rate or let it float. Even though your loan originator will guide and advise you with this decision ultimately it is up to you when and if to lock the rate in. Interest rates are based off different publicly traded indexed securities such as LIBOR (London Interbank Offered Rate) or the 10-year bond, just to name a couple. These indexes are constantly fluctuating and making this decision can sometimes be a daunting task.
When locking an interest rate, you need to understand that, once the rate is locked, should the rates go up you are protected. On the contrary, should rates go down after it locks you are stuck with the higher interest rate unless you have a float down option in place. If you are not satisfied with current interest rates you have the option to “float” the interest rate to any time prior to closing.
Some of the advantages to floating the interest rate are:
- If interest rates are to drop during the period of float, you can take advantage and lock in the lower rate
- The closer to closing you lock in the rate, corresponds to a shorter rate lock period and thus a cheaper rate lock cost
Some of the disadvantages to a floating interest rate are:
- While floating if interest rates are to increase, you will be stuck with a higher rate than if you had originally locked
- You may cause a delay in closing, sometimes additional documentation is required to lock in your rate
Once a rate is locked, the corresponding investor will reserve the money with the intent to fund that loan. The longer that that money sits without earning interest, the worse it is for the investor. Thus, the longer the rate lock, the higher the cost to the borrower. Lock in periods are generally available for 15,30,45, and 60-day periods. Remember the loan must close inside the lock in period, if the loan does not fund within the lock period the borrower will have to pay either a higher interest rate (if rates where to go up) or a fee for extending the lock period.
The float down option can be a valuable option should you be looking for extra security if interest rates drop. For an extra fee, you can take advantage of a float-down option (if available), should interest rate drop during the time you have it locked in, you can float it down to the lower interest rate.