Why you should lock in your mortgage rate now

Thinking of buying a home? Keep reading to find out why a rate lock is a good idea.

Why you should lock in your mortgage rate now

Now, more than ever, banks are encouraging homebuyers to lock in their mortgage rates.

Why? Well, the answer seems simple enough: Potential homebuyers may want to lock in a mortgage rate to protect themselves against a potential increase in interest rates, says TJ Freeborn, a mortgage professional at Discover Home Loans.

But any advice regarding real estate deserves more investigation and explanation. So if you're wondering whether or not you should lock in your rate, keep reading to demystify the rate lock and find out if it's right for you.

Why should you consider rate locking now?

Locking in an interest rate is a fairly simple process in which the lender commits to a specific interest rate at a specific cost to the borrower for a specific period of time, explains Malcolm Hollensteiner, director of retail lending products and services at TD Bank in Washington D.C.

And as mentioned, rate locks were created to help protect homebuyers from sudden changes in the market. So the most common reason for locking is simple: Most people lock rates when they are concerned about a rising rate environment, according to Chuck Price, associate vice president of lending at NEFCU, a Long Island-based federal credit union.

"In a volatile upward moving market, the earlier in the [mortgage] process you lock the rate, the better," he adds.

This might be the case now, as rates have begun to rise from their lowest point in 2012 - and will continue to do so, says Sean McGeehan, a mortgage loan officer with Peoples Home Equity.

The Mortgage Bankers Association (MBA) Mortgage Finance Forecast, released in May 2014, appears to back this up. Rates on 30-year fixed rate mortgages are projected to go from 4.4. percent at the beginning of 2014 to 5 percent by the end of the year.

With the rising trend through 2014 and beyond, it's definitely a good time for locking, since rates are still low right now, says McGeehan. And securing a lower interest rate means lower monthly payments and a reduced amount of total interest paid over the life of the loan.

[Ready to shop for a mortgage? Click here to compare rates from multiple lenders now.]

How much does it cost?

One thing to keep in mind, however, is that rate locking is not free. According to Hollensteiner, the cost of the lock-in is directly related to the number of days that the borrower needs to lock-in the rate.

"The shorter the lock-in period, the cheaper the cost of the lock-in will be," Hollensteiner adds. "In terms of an industry standard in today's mortgage environment, a 60-day rate lock is the norm."

So how much will rate locking cost you? The rate lock cost is a percentage of the interest rate, not a fixed dollar amount fee, Hollensteiner explains.

"[That] means the exact cost and terms of the rate lock will depend on the individual contract and lender," he adds. For example, a 60-day rate lock can cost 0.5 to 1 percent of the loan rate, or buyers can agree to a slightly higher interest rate to cover the cost, Hollensteiner explains.

When is the best time to lock in a mortgage rate?

When it comes to locking a rate, homeowners have plenty of options. That's because buyers can typically lock-in any time from the day of the application until four or five days prior to closing, according to Hollensteiner.

Price agrees, adding that borrowers should view locking rates as part of the overall mortgage process - and as a result there is no such thing as "the perfect time" for locking.

"Some borrowers are more comfortable locking after they've known that any predictable hiccoughs, such as title issues, are unlikely," Price says. For others, the best time for locking is after the appraisal has been completed and the borrower's financial documents have been received by the lender, Freeborn adds.

All of these potential bumps in the road - from a title issue to a lender not receiving all the loan documents - could cause a delay in the mortgage application process. Then a rate lock might need to be extended for a longer period of time, which raises the interest rate.

So how do you know when you should lock? According to Price, you should keep an eye on day-to-day fluctuations to help you gauge when it's the right time to lock.

"Reports on the job market, corporate earnings, or consumer confidence can, for example, impact the bond market which will then in turn impact mortgage rates," Price explains. If the trend has been for rates to inch higher during the last few weeks, Price says it might make sense to lock as soon as possible to avoid even higher rates.

[Ready to get a mortgage? Click here to compare lenders and interest rates now.]

Who shouldn't do a rate lock?

Because interest rates are still very low compared to just a few years ago, McGeehan believes about 95 percent of borrowers would benefit from locking in a rate. Why? He explains that waiting things out and "playing the market" can be dangerous.

"Oftentimes there is little upside and you could be stuck with a worse rate than with what you started with, so locking is usually a very good idea," says McGeehan.

Who are the other 5 percent that could skip the locking? Individuals who understand the market and happen to be in some sort of financial industry for their full-time profession, McGeehan explains.

"There is a small group of people who understand how the market determines rates, and they are likely to 'play the rate game' a little more," he adds. But everybody else is better off locking.

Plus, McGeehan adds that locking in a rate is not just about saving some money, but also about peace of mind.

"Locking the rate is security and safety for the homeowners," he explains. "It sets the expectation and lets them have control over what they choose to pay on their mortgage in a market where mortgage rates can fluctuate on a daily basis."

What are the drawbacks of a rate lock?

A potential risk is if you lock a rate today and rates drop substantially soon after, McGeehan explains.

"Should interest rates decline, a buyer who locked in at a higher rate may not receive the rate improvements," says Hollensteiner.

And while it might still be possible to switch to the lower rate and relock at that new percentage, there will be a cost to the borrower to lock-in again at the lower rate, according to Hollensteiner.

Is that cost ever worth it? Well, determining if breaking the lock is "worth it" depends on a number of factors, including how much the interest rate has decreased, what non-refundable fees may exist (e.g. application fees or expenses owed to the lender or seller), or the length of time a buyer plans to stay in the property, Hollensteiner explains.

The Bottom Line

If you're convinced that locking in a rate is the right choice, we have one more piece of advice for you. No matter when or how you choose to do a rate lock, it's a good idea to compare rates from multiple lenders. Since rates can vary from lender to lender, shopping around is another way to make sure you get the lowest rate possible and to make purchasing a home that much more affordable.