Locking in a low interest rate can save you thousands of dollars.
- Interest rates are on the rise in 2022.
- Most lenders allow you to lock in a rate, just in case they rise before closing.
It’s simple math: The lower your interest rate, the less you’ll pay in interest over the life of your mortgage. That’s more money to put toward things like saving and investing for the future. If you’re in the process of buying a house, it’s essential to know about locking in your interest rate. Here, we’ll cover a mortgage rate lock, how much it costs, and three reasons you may want to consider locking in your rate.
READ MORE: How to Buy a House
What’s a mortgage rate lock?
Typically, you apply for a mortgage, and if your loan application is approved, you’re offered a specific interest rate. Let’s say it takes 60 days from the time you make an offer on the house to when you close. If the interest rate rises before closing, the rate you were initially quoted goes out the window, and you’re stuck with the new, higher rate. You get the latest, lower rate if the mortgage rate goes down.
Locking your rate in allows you to know for sure how much you’re going to pay, so you don’t have to think about what happens if the rate goes up before closing. Lenders allow you to lock in a rate any time, up to five days before closing is scheduled.
Here are three reasons you may want to consider a rate lock:
1. Rates are on the rise
Many factors — including the U.S. economy, mortgage demand, and geopolitical turmoil — determine whether interest rates inch upward or downward. Because the U.S. economy is on track, interest rates are rising. Simply put, the Federal Reserve isn’t as worried as they were a few months ago about how the economy is doing and feels safe raising its federal funds rate (the rate at which banks loan money to each other and the foundation for consumer interest rates).
All that to say, there’s little reason to believe interest rates are going to go down over the next few months. If they don’t go down, there’s a good chance they will go up. Locking your rate now means you’ll end up with a lower interest rate than you would if you let it ride until closing.
Most rate locks last from 15 to 60 days, depending on your lender. If you’re serious about locking in a rate, check these four things before settling on a lender:
- How long the rate lock lasts
- Your scheduled closing date
- If the rate lock is free
- If you have the option to extend the lock period
2. You can create a budget based on reality
Let’s say you put 20% down on a $300,000 home. Initially, you’re offered an APR of 3.25%. Your payment (principal and interest only) is $1,045 per month. You decide not to lock in the rate, and by the time you close on the property, the APR is 4.25%, and your new principal and interest payment is $1,181 per month. It’s only $136 more each month, but over the life of a 30-year mortgage, you’ll pay an extra $49,000 in interest — simply because you’re locked into an interest rate that is one percentage point higher.
Now, imagine you created a budget based on the lower interest rate and ended up paying more because the APR jumped. Not only would you need to rework your budget, but if you’re a long-term planner, you would also need to rework how much you can expect to have in retirement one day.
3. You can’t afford a higher rate
Due to low inventory, housing prices are historically high. If a jump in mortgage rates would make it tougher for you to qualify for the mortgage, locking in a lower rate now is a good idea.
Even if a lender tells you that you qualify for much more than you applied for, you know how much wiggle room you want in your monthly budget. Cutting your finances close, even if it’s been recommended by a banker or real estate agent, is a recipe for financial anxiety. Why take the enjoyment out of buying a new home by introducing financial discomfort?
Some lenders offer a float-down option, a feature that allows you to snag a lower interest rate if the rates drop after you’ve already locked in your mortgage rate. Most lenders will charge you for this option, and some charge as much as 1% of the purchase price. On a $300,000 mortgage, that’s up to $3,000.
If the interest rate drops before closing, you may get to take advantage of the lower rate. That’s because each lender has its own set of rules. For example, some lenders may say the rates must drop between 0.25% and 1%. If the rate only drops 0.20%, you would not be able to use the option. In addition, you must have the lender’s approval before activating the float-down option.
Before spending money on a float-down option, ask a lender the following four questions:
- How much does the rate have to drop before I can take advantage of the float-down option?
- How much is the float-down fee?
- When does the float-down option expire?
- Under what conditions would the lender not approve the use of the float-down option?
Cost of mortgage rate lock
Many mortgage lenders charge nothing for a mortgage rate lock and even allow free extensions. Among mortgage lenders that do charge a fee, you’ll typically pay between 0.25% and 0.50% of the total loan amount, payable at closing. That first rate lock will last 60 days or less, and if you need an extension, it will cost between 0.06% and 0.375% more. So, if you borrow $300,000, you can expect to pay between $750 and $1,500 for the first lock, and $180 to $1,125 for an extension.
Again, if you want a free rate lock and extension, make sure that’s something a mortgage lender offers before borrowing. If there’s a fee for a rate lock, measure that cost against how much you’re likely to save in interest over the life of the mortgage.
A historic opportunity to potentially save thousands on your mortgage
Chances are, interest rates won’t stay put at multi-decade lows for much longer. That’s why taking action today is crucial, whether you’re wanting to refinance and cut your mortgage payment or you’re ready to pull the trigger on a new home purchase.
The Ascent’s in-house mortgages expert recommends this company to find a low rate – and in fact he used them himself to refi (twice!). Click here to learn more and see your rate. While it doesn’t influence our opinions of products, we do receive compensation from partners whose offers appear here. We’re on your side, always. See The Ascent’s full advertiser disclosure here.