Wednesday, December 30, 2009

Lock or Float Your Interest Rate?

When it comes to guessing the best time to lock in a mortgage interest rate, I’ve seen easier games on the carnival midway. Hitting everything just right so as to capitalize on the best rates and costs is not impossible, but it can be quite daunting in today’s volatile market.

Before the recent downturn in the real estate industry, the movement of mortgage rates was relatively easy to predict. But now the key indicators that once predicted the movement of mortgage interest rates are not as closely linked to the actual rates on any given day. Making it further difficult to predict, rates may fluctuate by 25 or 30 basis points in a few hours or a few days. Even the experts confess to having greater difficulty giving advance notice of rate movements.

Interest rates are usually locked for 30 to 45 days, depending on the time stipulated in the purchase contract. At the same time, rate locks are available for 60 and 90 days while some lenders offer locks up to 180 days. Borrowers can expect to pay a premium for longer lock periods, and these prices can very widely between lenders. Most lenders require that the loan be locked between 7 and 15 days before closing.

First, Find a Home. Most lenders require an address to lock a loan. This is one way the lender knows the borrower is serious about actually purchasing their financing. When the rate is locked, the lender is committing their money to you at that price. Once that amount of money is committed, they can’t use it to secure someone else’s financing. So, lenders take rate locks very seriously.

Second, Track the Time. The average purchase contract is written for 30 days. But if your situation is different, you need to make certain that your rate lock won’t expire before your scheduled closing date. In fact it’s a good idea to check with your lender the seven days prior to closing just to make sure your loan will close before the rate expires. If there is a question about this, request a rate extension.

Third, Bank the Benefit and Sever any Surprises. Most borrowers find a rate they can live with and lock it in. This way, they know what their monthly payment will be and can budget for it. Further, they simplify their home buying experience by limiting the number of distractions they have while waiting to close.

There are still some buyers who can’t resist the urge to “play the market” and they will choose not to lock their rate but instead “float” it hoping for a market improvement and a lower rate. What they hope for is a dramatically lower rate. In the best real life scenario what they actually receive is a slightly lower rate, perhaps as much as .125%. Unfortunately in many cases the rate actually increases by the same 1/8th of a percentage point. You win some, you lose some. This is why most borrowers choose to lock their rate instead of float.

Having said all of this, some lenders offer a “float down” option for their interest rates. This option (usually accompanied by a fee…of course) allows the borrower to re-lock at a lower rate, should rates drop by a specified amount during the time their loan is in processing.

Fourth, Follow the Fed. Earlier this year the Federal Reserve announced plans to buy up more than $1 Trillion in mortgage-backed securities. The reason this is so important is because interest rates on fixed-rate mortgages are determined by mortgage-backed securities that are traded on the bond market. When demand for these instruments goes up, fixed interest rates drop, and vice-versa. This promise by the Fed has helped keep rates lower throughout the last few months of the year.

It is not certain what the Fed will do after the first of the New Year. What could happen (emphasis on the could) is that the market for mortgage backed securities could shrink a bit driving down the demand and causing rates to rise.

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