Should I Lock In My Interest Rate?
The interest rate on your loan is not automatically fixed when
you apply for a loan. Unless you
the rate, the rate on your loan will "float" based on market conditions.
Should you lock in?
The Case for Locking In
If you think that interest rates will increase
before you close on your house, you
should consider locking in. There are three main reasons to lock
- Interest rate stability.
Locking in guarantees that the lender will fund your mortgage
at the agreed-upon interest rate, with the agreed-upon
- Peace of mind. If you are risk-averse, there is
comfort in knowing that your interest rate will not rise
- Loan approval. If you have not locked in and
interest rates rise,
the lender could reconsider your loan application, perhaps denying
your loan or asking for a larger down payment.
Lenders charge a fee to lock in. The fee is usually a percentage of
the loan; the longer the lock-in period, the greater the percentage.
The Case for Floating
On the other hand, if you think that interest rates will decline
between the day you apply for the loan and the day you close on the loan,
you might let the rate float. Floating has the following advantages.
- Opportunity for lower interest rate.
If interest rates do decline, you will be rewarded with a lower
monthly payment and reduced interest expense.
- Flexibility. If interest rates fall,
you can change your mind about floating and
lock in at a more attractive rate. (Note: Your lender may
limit your ability to lock in as the day of closing
- Zero fee. There is no charge to float a
Of course, if rates increase, you may pay a penalty for floating -
increased interest expense and a higher monthly payment.
A Framework for Decision-Making
It is impossible to know with certainty whether it will be better to lock
in or float the interest rate. However, you can improve the odds of
making a correct decision. This section describes how.
First, you need to understand what constitutes a good lock-in
decision. Most home buyers believe the following:
- Home buyer locks in. If rates rise, this was
a good decision, since the home buyer locked in at a lower rate.
If rates fall, the decision was bad.
- Home buyer lets rate float. If rates fall,
the decision was good; and if rates rise, the decision was
The above analysis is too simplistic, and not always correct. It
ignores the cost of locking in. Suppose, for example, that the
home buyer decides to lock in. For that decision to be
correct, it is not enough for interest rates to just rise; they must rise enough
for the added interest expense to exceed the cost of locking in.
Therefore, to make an informed lock-in decision, it would be helpful to know
how much interest rates would have to rise to cover the cost
of locking in. Using this site's
the analysis is easy. To see how it is done, review the
lock-in case study.