What is a Mortgage Lock-In Rate? The Complete Guide with Everything You Need to Know

If you are looking to make one of the biggest purchases of your life then you are most likely also looking for a mortgage. Navigating this process is …

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If you are looking to make one of the biggest purchases of your life then you are most likely also looking for a mortgage. Navigating this process is complicated and can sour the experience of something like moving into your first home. There is a nearly endless list of variable that is a part of getting a mortgage and understanding them all is something that is usually left to the banks that are loaning the money.

One element that is important to consider when looking into a mortgage is a lock-in-rate option. There are thousands of dollars in the balance connected to this concept. What serves you and what serves the banks is not always the same when it comes to lock-in-rates so you shouldn’t rely on them for the best information. This guide will help you learn everything you need to know to decide if you should opt for a lock-in-rate for your upcoming mortgage.

How Do Mortgages Work In The First Place?

A mortgage is a binding agreement between a lender and a borrower for a sum of money and a relatively long term over which the borrower pays back the loan with interest. Mortgages are almost always used when the borrower is planning on purchasing something with a very large price tag. By using the mortgage system they can buy something large, a home, boat, etc. and utilize the lender’s service to pay the large price incrementally, usually month to month.

This arrangement is obviously beneficial for the borrower because it allows for access to material goods that would otherwise be cost prohibitive. It is beneficial for the institution loaning the money because of what is called an interest rate. Conceptually, interest rates are the functions the lender uses to charge the borrower a certain amount of money for access to the loan itself. For this reason, those who take out mortgages ultimately end up spending more than they would if they had purchased whatever it is that they wanted in cash up front. Instead, they pay the bank a little extra for the ability to spread the price tag out over a few years or decades.

Interest rates are usually expressed by a percentage. The bank or other lenders may charge 3% of the total amount borrowed on top of requiring that the sum total of the loan be paid back.

What Is A Mortgage Rate Lock?

A rate lock is a contract between a lender, like a bank, and the borrow that ensures the borrower that the rate connected to their mortgage is going to remain the same over a defined length of time. This type of agreement is binding for both parties. Usually, the rate that is prevalent on the market at the time the mortgage is formalized will be what is realized in the payment plan over the course of the agreement. Read more about the benefits of locking in your mortgage rate.

Because interest rates are prone to change over the long time periods that mortgages cover it can be an intriguing idea to avoid change in what you would be paying from month to month by essentially choosing one rate and working only with that.

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Risks

This simplicity may present risks, however. Just as you may be avoiding changes in rates that would hurt your bottom line you are also avoiding rates becoming more favorable to you. If the market takes a turn that forces lenders to reduce their interest rates you would effectively preclude yourself from taking advantage of the reduced cost of your loan.

Another risk strikes at the heart of only the corrupt banks. Some banks have been known to let the period that your rate is locked in for the lapse. This is done during periods when rates have increased. Unable to do anything the borrower is at that point stuck paying rates higher then they were expecting or even able to handle. This can lead to defaulting on the loan which may result in losing whatever it is that was purchased with the funds from the mortgage. For more on risks click here.

How Are Interest Rates Determined?

There are three institutions that exert forces that affect what a given interest rate is going to be. The banking industry has a little freedom in what they are going to charge you for the ability to get a loan. This has a whole list of factors that go into it. Essentially they are going to determine how likely you are as an individual to pay back the money they are going to give you. If they are convinced you are going to pay your bill to them on time then they will give you a lower interest rate. They value the surety of payment that a deal with you has to offer.

If you have had a bad history with loans and payments in the past, or if they discover other factors that indicate that you are not going to have a high likelihood of paying off the loan then you are going to be given a higher interest rate. They hedge against the likelihood that you are not going to pay the whole loan back and therefore get their return on investment by charging higher rates.

The other two forces that affect what your interest rate will be are the Federal Reserve and the demand for U.S. Treasury notes and bonds. The Federal Reserve sets what is called the fed funds rate. This affects short-term and variable interest rates.

Timing

After reading the above sections it is easy to understand that being aware of how interest rates are operating in connection to a specific loan is critical to having a positive outcome. The question then arises as to when the best time to obtain a rate lock freeze is.

It is important to know that borrowers are not able to secure an agreement locking at a certain rate until after the loan is approved. Another thing that goes into the logistical timing of securing a rate is how soon you are going to be spending the money that you receive from the loan. If you are looking to buy a home, for instance, you will not want to lock in a rate until you know the specific house that you will be buying is yours for the taking.

As a general rule of thumb the longer a rate lock is on the front end the more expensive it will be. That means that if you want the bank to hold today’s interest rate for thirty days before the loan is formalized it will be less expensive than if you need the bank to hold the rate for sixty days.

The sixty-day hold may still pay off, however. It depends on what the market looks like it is going to do. If rates go up even a small amount it can turn into thousands of dollars on the back end of the loan. If it seems like a total gamble as to when or if you lock in a rate then you are going to what to look into some resourcesfor discerning what rates look like and what they will look like.

Mortgage Requirements

If you think that locking in a certain rate then there are a few things that you are going to want to check on so that you are totally prepared to accept a loan when the time and rates are where you prefer them to be. Qualifying for a mortgage involves your credit scores, how much debt already have and will have, and your income among other things.

While there are several types of mortgage loans that you could be applying for the conventional loan eligibility requirements will provide a common enough picture of what is involved.  A standard thirty-year or fifteen-year loan requires the ability to pay a down payment. This means that you will pay a larger portion of the loan back right at the beginning. It can be as low as 3% and can be as high as can be negotiated between the parties.

If your down payment is going to be less than 20% of the total loan then you are going to need to carry and pay for private mortgage insurance. This usually shakes down anywhere from less than 1% to 2% of your loan balance every year. This will proceed until you have paid over 78% of the loan balance back to the lender so long as you have maintained a solid pattern of getting your payments in on time.

Your credit score will also be evaluated to determine if you are responsible for a mortgage. Generally, you are going to need at least a 620 on your report. This is various across the different lenders with some being as strict so as to require a score of 640. The score determines a yes or no to a loan but also the interest rate of the loan after you are approved.

The higher your score the lower your interest rate will be.

Wrap Up

Now that you know that a mortgage lock-in rate refers to the process of establishing a single rate to be used for the duration of your loan it is up to you to determine if that is going to be the right thing for you. Weigh the pros and cons against each other and work with your bank to see what kind of hypothetical situation can be painted to educate your decision.

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