How Do Rate Locks Work?

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By Richard T. Cirelli, President, CMPS

RTC Mortgage Corporation

Locking in the Rate is a very important aspect of the mortgage process. The recent increased volatility in the financial markets brings Rate Locks to the forefront. When is the rate locked? What happens if rates go down after I lock? What if the rate lock expires before my loan closes?

These are the typical questions asked. I hope I can shed some light on this topic.

 

The Basics:

First of all, understand that mortgage rates change every day and throughout the day. Lenders allow us to lock in our borrowers’ interest rate in order to protect them from potential increases in rates between the time they make their application and the time the loan closes. At the same time, a rate lock protects the lenders and allows them to manage their pipeline of pending loans to try to minimize losses from loans that don’t close. So, it’s a two-way street in that once a rate is locked the Lender can’t raise the rate before the loan closes or the lock expires and they also won’t lower it if rates eventually fall (see the paragraph about exceptions near the end of this article).

It should be understood that a Lender will lose money when a rate lock is broken because they “hedge” their pipeline by buying securities that move in the opposite direction of interest rates. They also incur a cost when they substitute one loan for another in their pipeline.

Rate locks are always for a finite period of time. Most lenders will offer a rate lock in 15-day increments, i.e., 15, 30, 45 and 60 days. The longer the lock-in period, the higher the cost because the lender is at risk for a longer time while guaranteeing a rate.

 

When Can the Rate Be Locked?

A rate can be locked anytime during the process. In a “purchase” transaction it can be locked once the buyer and seller have a signed purchase agreement and escrow is opened. On a refinance transaction it can be locked in once the borrower has made an application and signed an “intent to proceed” with a lender or mortgage broker.

Since rates can change daily, timing is all-important. It’s not always best to lock in the rate at the time of loan application. An experienced mortgage broker has resources that track the movement of mortgage-backed securities and receives “alerts” when the time is best to lock in. It’s not a perfect indicator of when to lock but an experienced mortgage broker will manage his pipeline according to closing dates and the lenders he has chosen to work with, while keeping the best interest of the client always in mind. The big banks, on the other hand, tend to lock all loans at time of application which is not often the best time.

 

Can a Rate Lock Be Broken?

As a general rule, a rate lock is a commitment for both the borrower and the lender. But, sometimes there are extenuating circumstances, such as the substantial decrease in interest rates we just experienced. When that happens, lenders may allow us to “negotiate” the rate to the market-rate or somewhere between the market rate and the locked rate. The lender has to evaluate how much it will lose if it negotiates the rate, and the borrower has to evaluate whether it’s worth the hassle of starting over with another lender. Each lender has the ability to set its own policy for rate negotiations and most lenders won’t negotiate the rate until the loan is ready to close. You can’t expect them to negotiate every day as the markets change. A rate negotiation is usually a one-time opportunity.                        .

Lock extensions can also be granted on a case-by-case basis. The lender will base its decision on whether the delay in closing was the fault of the borrower not providing the requested documentation in time or whether it was a result of its own inefficiencies.

Rick Cirelli can be reached at 949-494-4701 or Rick@RTCmortgage.com. You can also visit his website at www.rtcmortgage.com.