Mortgage Loans

Should you wait to lock in a mortgage interest rate?

(7/30/2012) - Wanda Smythe from Appleton, WI is elated that a seller accepted her offer to buy a home, but is concerned about when to lock in the interest rate.

An interest rate lock guarantees you a certain rate, and other costs, for a given term. Provided all the terms and costs are clearly stated, in writing, it's a good hedge in a rising rate market and a good tool to use to lock in a rate based on what you can afford.

Smythe has excellent credit and more than 20 percent down for a 30-year, fixed rate conforming mortgage at 3.6 percent, but lives on a fixed income and can't squander a cent.

The lender suggests she lock in the rate immediately. Her loan is due to close in 40 days. Assume the rate lock is a 45-day deal, and the loan closes in 40 days, giving her ample time to close with the rate locked.

Smythe is concerned that if she locks too soon she'll miss an even lower rate.

"I personally believe the rates will keep going down, though people think I'm crazy. I live on disability income, so every bit counts," Smythe writes.

Smythe isn't crazy, but making a decision will require her to gamble on interest rates and she must work some numbers.

Which way rates?

Rates have been trending down for weeks, and the Federal Reserve has all but promised to keep benchmark rates low well into 2014. The world economy and a struggling domestic economy, still troubled by a housing crisis that hasn't quite run its course, also add downward pressure on mortgage interest rates.

Recently, the average 30-year fixed rate has fallen to a new record low for each of four consecutive weeks ending July 26, according to Freddie Mac.

However, no one can predict if the trend will continue, if rates will go up or down, nor by how much. Pledging to keep federal benchmark rates low may not always translate to falling interest rates.

Compared to past strings of consecutive record lows, the current one is rare and unusually enduring. Statistically, that means another four weeks of falling rates isn't a good bet.

Smythe has good reason to pinch pennies, but she may be just a tad over wrought about her potential for saving money.

Do the math

Let's say the stars align in her favor and rates continue to fall for another four weeks at the same pace they've fallen in the past four weeks, ending July 26 - from 3.66 percent to 3.49 percent, a difference of 0.17 percentage points.

And let's say her rate dropped by an identical margin, from 3.6 percent to 3.43 percent.

ZIllow puts the median sale price of homes in Appleton, WI at about $115,000. Deduct her 20 percent down and she's financing $92,000.'s calculator says her payment at 3.6 percent would be about $418 a month. At the lower rate of 3.43 percent, the payment would drop to about $409 - a difference of only nine bucks. Even if rates drop more, say to 3.25 percent, and that's a stretch, the payment would be about $400 a month, an $18 a month savings.

Is saving $9 or $!8 a month really worth the risk of rates turning around and costing an already strained fixed-income household a higher payment?

Probably not, especially if Smythe's budget can manage a $418 payment.

It's probably easier to save $9 to $18 a month elsewhere in the budget, without the risk.

Rate lock considerations

Smythe may be able to eat her cake and have it too with a rate lock that includes a "float down" provision.

The common rate lock protects borrowers against rising rates.

Floating locks comes with the option of a lower rate should rates fall within the term of the lock.

As is the case with all rate locks, everything must be clearly stated in writing. Unless specified otherwise, float downs can stick you with a higher rate if rates rise during the lock period.

Finally, rate locks cost money. Float downs, typically cost more than a conventional lock because the lender is taking on a greater risk that it will have to write a loan with a smaller return.

Again, Smythe has to gamble and do the math, first to wager if she'll actually realize savings from the cost of the float down and then to calculate if the cost of the float down - with or without a cheaper rate - makes sense to her tight budget.


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