To lock an interest rate or not lock, that -- with apologies to Shakespeare -- is the question.

Borrowers always wonder if they should lock-in interest rates when they first apply for a loan -- or should they wait and see where the market goes. There is no sure answer because either choice involves some risk. If you lock now and rates fall, you lose. If you don't lock now and rates rise, you also lose.

Alternatively -- and here's the good news -- you win by locking before rates rise and you also win by not locking in a market where rates are falling.

What to do?

The first step is to understand how the locking process works. In essence, there is no single lock-in "standard" -- a "lock-in" with one lender may be radically different from the lock-in program with another. Here are some issues to check:

• What is being locked-in? An interest rate? Or an interest rate and points? Given that "points" are a form of interest, if a rate is locked-in but not points, then the effective rate for the loan can rise before closing if the interest level stays the same but the number of points increases.

• How long is the lock-in? A typical lock-in lasts 30 days, but longer terms may be available.

• Is there a cost to lock-in? If you pay a fee for a lock-in and borrow at a different rate or from a different lender, then the lock-in fee will be lost. In some cases, lenders collect a lock-in fee and then credit the money to the borrower at closing. In this situation there is no additional cost to lock-in if you go through with the loan.

• What does the small type say? Some lenders have been known to lock-in rates -- unless "market conditions" change, then all bets are off. But ask yourself a question: Is there ever a time when "market conditions" do not change? Surely there must be a reason why interest rates change daily if not more often. In this case, the fine print effectively defeats the benefits a borrower wants from a lock-in.

• Is there a "float down" option? In this situation you lock-in a rate -- say 7 percent and 1 point -- but have a one-time option to lock at a lower rate if interest levels and points fall.

• What happens if you can't close be the end of the lock-in period? Typically, you lose the rate you reserved. This is not unfair because a lender cannot be expected to hold a given rate indefinitely.

When you lock-in a loan, lenders have one of two choices: They can secure a loan commitment with an investor at the promised rate or they can play the market and hope that by settlement they can get your rate -- or better.

But what happens if a lender plays the market and rates go up? The lender loses. The problem is that not all lenders play fair. It doesn't happen often, but some lenders will delay the loan application process past the lock-in period, thus ending their commitment to make the loan.

How can you avoid this problem? Consider lenders recommended by your broker. An experienced broker will know which lenders have a good record delivering on commitments.

In general, whether you lock-in or not, it's best to be in continuing contact with the lender. Make a point to promptly supply all required paperwork, and keep notes showing when you spoke with the loan officer and what was discussed. Get timed, dated, and signed receipts for all paperwork you deliver.

So when should you lock-in? There just isn't a single answer that works for every situation. You need to consider general interest trends -- and also that no one can predict future rates. At best, a properly-written lock-in can limit exposure to rising rates -- and that's not a bad deal.

For more information, speak with brokers and lenders -- and make sure you understand the terms and conditions of any lock-in agreement.

Published: June 26, 2001

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