What is a Mortgage Rate Lock and How Does It Work?

You have probably heard the term "mortgage rate lock" or "lock in your rate" when you are searching for a home. But do you know what this term means and how it is beneficial to you?

Until the US entered a period of historically low mortgage rates, mortgage rate locks were very common for those seeking to close on a property purchase. Rate locks are basically a guarantee that you can get a certain mortgage interest rate on your loan, provided you close or complete the necessary paperwork within the agreed upon time period. For example, you may get a lender to agree to lock in a 3.5 percent interest rate for a 30 year fixed rate loan for 15 days. If you close or complete the necessary paperwork, the lender will release the funds for your loan within the 15 day lock period; if you do not, the rate lock agreement is forfeited.

Here are some other things you should know about rate locks to get a better understanding of how they work.

  • When you get a mortgage rate lock, the lender typically charges you points in exchange for locking in the rate. A 15-day rate lock generally costs 2 points and it can go up from there. For a 30-day rate lock, you may be charged 2.25 points and a 60-day rate lock may mean paying 2.5 points. Mortgage points are basically a form of interest that you pay upfront. Each point is equivalent to one percent of the amount of the loan and you can purchase points in order to reduce the interest rate on your loan which, in turn, reduces the monthly payment for your mortgage loan. You only have to pay for these mortgage points if you end up taking the mortgage so there really is no downside to getting a rate lock on your mortgage.
  • Lenders run the risk of losing money by offering a rate lock because mortgage rates can increase during the locked period. If you have a 4 percent rate locked in and  mortgage rates go up to 5 percent, they cannot charge you the extra percentage rate as long as you purchase the house during the locked period. 
  • While banks cannot charge you a higher mortgage rate during the locked period, some banks may offer what is known as a free float down. This means that if mortgage rates drop during the lock period, the bank will offer you the lower rate. However, many banks charge extra for this option.
  • Many times, a mortgage lender will only let you lock in an interest rate on a certain property that you are considering purchasing. There are times, however, where a lender will let you lock in a rate before you find a house that you want to purchase. This is often called a “lock and shop” program which is ideal if mortgage rates are steadily increasing.
  • If you are purchasing a home that is new construction, you may find lenders that offer long-term rate locks. These types of rate locks cost a little more in points and they may also require an upfront deposit in order to guarantee the mortgage rate. These long-term rate locks can be as long as 180 days because it can often take longer to close on a new construction home if it is still in the process of being built and you may have an opportunity to get a lower rate if the mortgage rates drop during that period of time.

If you have been wondering about rate locks, these are just a few of the things that may help you understand this concept better. Your mortgage lender can give you more information about how many points you will be expected to pay and their specific rate lock programs and details.

Compare the best mortgage rates here.

The Factors Lenders Use to Evaluate Your Mortgage Application

When banks evaluate your application for a mortgage, there is a rough formula they use to determine how credit worthy you are and whether to approve your application. Understanding this formula can help you strengthen your application and increase your chances for getting the loan you want.

When banks and mortgage companies evaluate your application for a mortgage, there is a rough formula they use to determine how credit worthy you are and whether to approve your application. Understanding this formula can help you strengthen your application and increase your chances for getting the loan you want.

In general, there are four main criteria that banks and mortgage companies use to evaluate a borrower. They are: income, assets, credit, and appraisal.  Lenders do not just evaluate the quantity but also the quality of each criterion.

Income

Lenders look at how much money a borrower makes but also the stability of that income. Has the borrower earned similar amounts in past years? Is the borrower's employment status secure and have they worked at the same company for some time? Do they have a stable employment situation? A borrower who makes $10,000 in one year and $300,000 the next has the quantity but not necessarily the quality. Lenders like predictability.

Assets

How much money does an individual have in the bank and in investments? Has this amount increased steadily or because of a $50,000 gift from grandpa? Lenders like to see stable, year-over-year increases in assets. One time gifts do not provide the same level of comfort that the borrower can continue to increase savings every year.

Credit

Lenders look not only at the credit score, but also at the credit score trends. Has the borrower maintained a high credit score over time? Does the borrower have other debts that they have responsibly paid off? Has the borrower shown that they can manage debt? Lenders prefer an individual who has responsibly managed some debt over someone who has never taken out a loan before. So, in this case some debt is better than never having debt at all.

Appraisal

The amount that a house appraises for it important, but so is the quality of the appraisal. Borrowers want to see that the appraisal was done by an independent, qualified individual who can accurately assess the value of a house. Did the appraiser take the time to really inspect the house, take pictures, and evaluate the condition of the property? Drive by appraisals are a relic of the past.

Having quantity and quality in all four categories ensures that a borrower will be approved and receive the best possible rates. That doesn’t mean that a borrower can’t get a loan if quality or quantity is slightly low in one or two categories, but the chances do go down. Evaluate your own borrowing strength using the chart below.

 

Criteria Quantity Quality
Income Lenders like to see that mortgage payments, interest, insurance, and taxes will not exceed 28% of a borrowers gross income (pre-tax) income. This is called your debt to income ratio. Income is the second most important criteria behind Appraisal value of the house. Consistent income over time. Steady employment and stable or rising income.
Assets Lenders like to see that homeowners have substantial assets. Ideally the value of the assets would cover the mortgage amount but this is not necessary. This ensures that lenders will continue to receive payments should the borrower lose their job and income. Increasing asset growth over time is better than lump sum increases from a gift, inheritance, etc.
Credit According to myFico, Credit scores over 760 help a borrower get the best rates. The myFico site shows that the difference between a 760 and 639 credit score is nearly $300 per month on the same $300,000 mortgage. A credit report that shows a history of being able to manage debt.
Appraisal A house that appraises for at least the amount of the mortgage. If not, the house is considered underwater and lenders will not approve the loan. This may be the single most important criteria. A reputable appraisal done by an independent company.

Mortgage Rates Rise Slightly In Past Week

Average 30 year mortgage rates rose slightly in the past week but still remain within the 4 - 4.20% band they have fluctuated in over the past five months. Average 15 year mortgage rates also remain very stable, fluctuating between 3.4% and 3.6%

 

Mortgage rates

Jim O' Malley, a senior loan office at Leader Bank told me that "rates have been very stable the last 6 months. They dipped a little due to the Greek crisis but remain mostly stable. Rates are supposed to trend a little higher due to the improvement in the economy and the jobs situation improving month over month." As the economy improves, rates should also move up. Recent data shows that employment and consumer confidence is on the rise. Still, almost no one expects strong economic growth which means that while rates may rise, the increase will be most in the medium term.

As rates rise, lending requirements continue to remain tight. Jim said that "lending requirements are very tough and banking has become forensic on many levels. The pre-approval market seems to be improving so it looks like the Spring may be a busy season for purchases."

By forensic, he means that banks are taking a deep look at a borrowers financials. Be prepared to show that you have the income and financial wherewithal to afford the mortgage you are seeking.

Jim O'Malley also thinks many homeowners will be disappointed at what their homes appraise for unless they live in select areas that have seen limited price declines.

Case-Shiller data shows that housing values continue to drop. So, if you are sitting on the fence regarding buying a home or refinancing, now might be a good time to act. The future may bring higher rates and lower appraisals.