Rate Locks

A rate lock, or lock-in, occurs when a lender commits to a rate for a specified time before closing. A rate lock is a good idea because it protects the borrower from rates rising before the closing.

The reasons rate locks are necessary in the mortgage market are two-fold. The first is that the mortgage market is volatile. Rates can change every day, and sometimes more than once in a day. The changes may not be large, but they can be large enough on particular days to have a great effect on borrowers. The second reason locks are needed is lengthy process delays. Because of the complexity and size of a mortgage transaction, they take a while to process, and principal loans on newly purchased property can take a particularly long time to close the deal.

The combination of volatility and delay makes locks necessary. The need to lock-in a rate is fairly unique to the mortgage market, because other markets don’t have these two factors on the same scale as mortgages.

Consumers often are required to pay a fee in exchange for their rate lock, and the fee is higher the longer the rate is locked for. The fee is necessary to protect the lender. If rate locks were just as binding on the borrower as they are on the lender, then fees would not be required to lock in a rate.

The problem lenders face is that borrowers tend to abandon the transaction when rates fall considerably after the lock-in in favor of a new loan with another lender at a lower rate. If this were not the case, lenders would make as much money from borrowers when rates fall as they lose when rates escalate.

Some lenders charge no fees, or reduced fees, while requiring extensive documentation to lock. This assures the borrower will stay no matter what happens with rates, and reduces the need for fees. However, the documentation process can take up to three days, in which the borrower is taking a risk that rates will inflate before the lock is completed.