What it Means to Lock an Interest Rate

by Alex Stenback on April 27, 2011

Did you know that when you buy a home and negotiate a closing date you are also gambling a little with your interest rate?

This is because at some point between the day you sign your purchase agreement and the day of closing, you need to lock your rate, and length of time you need to protect the the rate actually has a lot to do with the available interest rates, or the costs you will pay to get a given rate.

Not enough homebuyers understand this.

To put it simply:  A rate lock is a transfer of risk.  Nothing more, nothing less.

Before you are locked, you are ‘floating.’ You bear all the risk of rising rates, but also retain all potential for reward if rates fall. 

Once you lock, you no longer carry interest rate risk, but will not benefit should rates fall – The lender now holds the risk/reward equation and part of that calculation includes the risk of time.

In some ways, locking a rate is like playing the futures market – you are locking in a price today, but when the loan is delivered, current market prices/rates will be different.

Not that you should fear this – innumerable financial decisions you make work this way – when you fill up your gas tank, you are making an implicit bet that the price won’t drop (otherwise, you’d wait if you can, right?) but filling the tank, like closing on a house, does eventually have to happen at a specific date and time, so there is always an element of lucky timing involved.

Anyway, back to the question at hand:  To the extent there is objectively more risk over time (we have a better idea where rates will be in 3 days than in 75 days,) the longer you need to lock your rate.  The longer the lock, the higher the rate (or fee/price for a given rate) is.  This is the lenders way of charging you for the risk of time.

Thus, all things equal, you get a better rate if you lock for 30 days than if you lock for 60 days, 60 is better than 90, and so on.

Bottom Line:  Keep that in mind when deciding when you’d like to close on your home purchase, you are making both a personal decision (when) and a financial decision (what price/rate )

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