Longer mortgage rate locks aren’t worth paying extra

After seeing mortgage rates spike last year, those now on the hunt for a house are wondering what they can do to limit the damage.

Some optimistic borrowers think rates will be headed down again and want to be able to take advantage of a dip. More pessimistic homebuyers want to ensure they can hang onto the lowest rate possible in case the market heads higher.

The average 30-year fixed mortgage as of Feb. 25 was 6.5%, according to Freddie Mac, down from a 20-year high of 7.08% in November but climbing again after falling to 6.09% in February. The consensus among housing economists has been that rates in coming months will be a bit less volatile than they were last year and will end 2023 below 7%.

Whether that will pan out is anyone’s guess. At the beginning of last year, the mainstream thinking certainly wasn’t that rates would rise as fast and high as they did.

Despite the uncertainty, last year’s tumult doesn’t justify this year’s borrowers paying for unnecessary insurance. While there are products that enable borrowers to lock in current rates beyond the standard 30-, 45- and 60-day period, or “float down” if rates fall, in most cases the extra cost of those products isn’t worth it.

First, a brief recap of how mortgage rate locks work. When a loan application is approved, lenders will typically guarantee an interest rate for a month or two until closing, even if rates move during that time. (The rate can reset if there are changes to the application, such as the down payment amount, value of home appraisal or a dip in credit score.) Most lenders won’t charge for that standard rate lock – though some may, or include it as part of the loan application fee.

Soaring prices and intense competition for homes during the pandemic has made more buyers jittery that the standard period won’t be long enough, putting them at risk of losing their guaranteed rate. Or some may hope to be able to move faster when they find the right house by locking in a loan while they’re still shopping.

Banks or other lenders sometimes offer an option to pay an additional upfront fee to keep a rate for more time, sometimes as long as six months. The cost varies, but generally it’s at least 1% of the loan amount to secure a rate for 120 days. On a $500,000 loan, that would be a minimum $5,000.

Or, for buyers who fear getting stuck paying more in a weakening market, there might be a separate, non-refundable cost of as much as 0.5% of the loan amount for the option to reset lower if rates decline. On top of that fee, lenders may even give you a higher rate at the outset for the flexibility to lock for longer or float down. Other lenders are offering ways for borrowers to hedge their bets. For example, last year Rocket Mortgage introduced a rate-shield product where for an extra fee homebuyers can lock in a rate, even before they find a house, for 90 days, with a one-time chance to reset if rates fall.

But playing the interest-rate game when buying a house is just as foolish as trying to time your investments in the stock market. Ultimately, you’re going to throw money away in pursuit of saving just an eighth or quarter of a percentage point, at most.

Sure, every little bit counts at a time when interest rates are almost double where they were before last year’s spike and housing prices are still 40% higher than pre-pandemic. But your money would be better spent paying an extra point (a fee paid to the lender to effectively buy down the rate), or just holding out to refinance in the future.

You might also be able to get the extra certainty you need by shopping around. There are some lenders that offer a long-duration lock or float-down for free.

The most dangerous gamble is when a buyer declines any lock at all because they think rates will fall before they close. In that case, they risk blowing up the loan entirely. Let’s say their loan has been approved at a certain rate, but then rates head higher instead of lower. Without a rate lock, they could lose the loan because their financial situation isn’t sufficient to qualify for the higher monthly payment the higher rate brings.

There are a few exceptions. If you’re buying a home that’s under construction or one that’s been foreclosed, which could delay closing longer than the standard period, paying more at the start for a longer-term lock could be worth it. Especially since it can be costly to extend a rate lock after the initial guarantee expires. Some mortgage brokers I spoke with said borrowers could be on the hook for $100 a day for rate lock extensions.

In that case, securing a longer lock can be prudent. But for most other situations, borrowers will be better off sticking with the standard free version, even now.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance.