Purchasing or refinancing a mortgage is a big decision. It affects one of the largest investments in your life. Obviously, you want the lowest rate possible. How do you get it, though? With rates changing on a daily and sometimes even hourly basis, it can seem impossible to secure the rate you want. One of the easiest ways is to lock your mortgage rate. But even this task requires a combination of skill and a bit of gambling. The general consensus is that you need to lock a rate at some point; however, deciding when to do so could be a work of magic.
What is a Rate Lock?
First, let’s discuss what a rate lock is and how it works. A rate lock is essentially a freeze on the rate you want. This rate has to be available at the time you request the lock. Once you sign the lock commitment, it is a contract between you and the lender. You are eligible for this rate for a specific number of days. You can usually choose the lock period, which often ranges between 10 and 60 days. The longer you lock a rate in, the more expensive it is for you. In general, most borrowers lock a rate for 30 days as that is often plenty of time to get to the closing. Once you have your rate locked, it is your rate no matter what rates do from that point on. This means rates could drop significantly or increase dramatically and your rate remains untouched.
Paying for a Rate Lock
Typically, you don’t pay for a rate lock, at least in the literal sense. You don’t have to fork over money to the lender in exchange for a rate lock. However, you do pay for it. The longer you want to keep the lock, the higher your interest rate. As a general rule, every 15 days you need to lock the rate, your interest rate increases 1/8th of a percent. The exception to the rule, however, is if you need an exceptionally long lock period. For example, if your purchase contract has your closing date set out 90 days or longer but you are intent on securing a rate, you may have to pay a point or two to the lender to lock the rate. This is in exchange for the risk the lender takes. Rates generally fluctuate quite a bit in 90 days. If the lender commits to a specific rate for you now for more than 3 months in the future, they stand to lose out on the deal. To make up for it, they will charge you 1 or 2 percentage points of your loan amount, which you pay at the closing in the form of discount points.
What Needs to Happen to Lock Your Mortgage Rate?
In order to lock your mortgage rate, several things have to happen. First, under no circumstances can you lock a rate until you have mortgage approval. The lender will help you determine when is the best time to lock once you have the approval, though. For instance, just having a preapproval is often not enough to secure a rate. Unless you have a really unique circumstance, there is no reason to commit to a specific rate yet. A preapproval just means you can secure a loan, but after many conditions are cleared. If you don’t have a purchase contract yet, there is no reason to think about rates.
In most cases, lenders require a signed sales contract in order to secure an interest rate. This way the lender knows not only that you are serious about purchasing a home, but also the closing date. This key piece of information helps the lender know how long you need to keep a specific rate. For example, if you purchase a new construction home, your closing date may be six months or more down the road. There is no reason to settle for a rate just yet. If you purchase an existing home, though, you may be able to secure your rate right away if the closing date is within the near future.
How to Time your Rate Lock
Timing your rate lock is where the magic comes into play. History may show that there are certain days or times of the week to lock your mortgage rate, but this is not always accurate. In general, you might find better rates at the end of a week. This is because the week is almost over and anything that may happen has already occurred and the market has had a chance to react. Other experts state that the beginning of the week is better because it is a “fresh start” and nothing happens quite yet. The right timing is really up to you and how you feel.
If you know of a major event that affects the markets overall, you may want to pay close attention. You will likely hear about any sharp changes in rates on the news or from your loan officer. You can judge by the occurrence what you should do. For example, if rates drop dramatically, you may want to jump on the opportunity, even if you have a long-standing lock period. If they rise, you may want to hold off until the dust settles and things go back to normal.
Deciding What Risks you Can Take
Before you lock in a rate, think about what risks you can take. Do you want to ride it out until the last minute? Some people do this, hoping that rates drop enough for the gamble to be worth it. If you are not a risk taker or know you cannot take a chance at a higher rate because your debt ratio is very close to being unacceptable, you may want to lock in sooner. The best way to decide is to take a close look at your situation. How do you answer the following questions?
- How close is your debt ratio to the maximum allowed?
- How much wiggle room do you have in your desired payment? If it were to increase, say $50, would it be a hardship for you?
- How soon is your closing? If it is too far away, you may want to wait.
- Would you be really upset if you locked in and rates went down?
- Do you have an “ideal” rate in mind?
Answering these questions can help you determine what risks you can take and how well you can ride it out.
In the end, you have to lock your mortgage rate at some point. It is up to you when you actually bite the bullet. Remember, you have to live with the rate you lock, no matter how dramatic the market gets afterwards. Locking as late as you can takes the drama out of the equation because you won’t have a lot of time for things to change dramatically before you close. However, remember, you are not stuck with this rate for the rest of your life. You can always refinance down the road if you find that rates decrease enough to make it worth it for you.
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