When you buy a home or refinance, you go into escrow, and at that time, you are asked whether to lock the interest rate. The escrow period is approximately 30 to 45 days, and no one knows how the interest rate will change during this period. So consumers use a method called “Interest Rate Locking” in hopes of getting a lower interest rate. There is a price to pay when you lock the interest rate.
You pay a fee called a “locking fee.” When you lock a rate, you can usually lock the rate for 15-45 days. However, the longer the locking period, the more it costs. “Locking” a rate means applying a lower interest rate, but it is a mistake to think that locking a rate guarantees you the lowest interest rate. This is because interest rates fluctuate frequently. Typically, banks charge an additional 0.25-1% of the loan amount to hold the desired interest rate for 30 days. However, if you lock a $400,000 loan at a 30-year fixed rate of 4% and the interest rate goes up to 4.5% 2-3 weeks later, you will be sufficiently compensated for the locking fee. For example, the monthly payment for a 30-year fixed 4% loan of $400,000 would be $1,909. If the rate is not locked and the higher interest rate of 4.5% is applied, the monthly payment will be $2,026. Furthermore, if the rate is not locked, the high interest rate will be applied, and the loan itself, which had been approved when calculating income at a lower interest rate when starting the loan, may fall through. This is a very rare occurrence. For example, if the loan applicant barely meets the conditions for monthly payment at a 4% interest rate, the monthly payment will increase from $1,909 to $2,026 if the interest rate is increased to 4.5%. The difference is $117. However, if this small difference exceeds 1/3 of the debt-to-income ratio (DTI), it may become impossible to get a loan. In what cases exactly is it advisable to lock the interest rate? It is advisable to lock the interest rate if there are signs that interest rates are likely to rise soon. For example, when inflation is expected due to economic overheating, interest rates are likely to rise. In this case, it is advantageous to lock the interest rate and start the loan.
Here is the locking procedure. Unlike in the past, there is no prepayment required to lock the interest rate these days. When fixing the interest rate, in addition to the locking documents, you also need to prepare a loan application, credit report, and escrow instructions. Some banks only validate the lock if the loan documents are submitted to the bank within 2-3 days after the lock, and if the documents are not received, the lock itself is invalidated. When is locking not necessary? If there are signs that interest rates will fall due to an economic downturn, there is no need to lock. Leaving the interest rate as it is without locking is called “floating,” and in this case, the interest rate at the time the loan is finalized is applied. Understanding economic trends is possible when consumers can decide whether to lock/float the interest rates of their home loans and refinancing funds. When news comes out that the economy is doing well, it can be interpreted that the Treasury's bond/securities interest rate may rise, which in turn means that housing interest rates may rise. If consumers are not aware of these economic trends, they are advised to follow the advice of a housing loan expert.
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