When Is the Right Time For a Mortgage Lock?
April 23, 2001, Revised September 13, 2005, January 23, 2011, January 17, 2012

Should Borrowers Forecast Interest Rates?

"I have been pre-approved for a loan on my new home but have yet to lock in the interest rate. When would be a good time to lock, and what indicators should I be looking at?"

"They say that interest rates will be reduced at the next meeting of the Federal Reserve Board, so I intend to wait until after the meeting to lock."

These letters assume that it is possible for mortgage borrowers (or their advisors) to forecast the direction of interest rates with a better than 50-50 chance of being right. In my view, that is wrong.

There are a lot of professionals out there who spend their entire working time analyzing the market, and who have a lot of money riding on the accuracy of their interest rate forecasts. Over time, virtually all approach 50% accuracy. Even if there are a few who do better than that consistently -- and I don’t know who they are -- a non-professional doesn’t have a chance.

Prior to the meeting of the Federal Reserve Open Market Committee on March 20, 2001 it was reported widely in the news media that interest rates would be reduced, the only question being by how much. This expectation was confirmed when it was announced after the meeting that rates were being cut by ½ percent. But whatever impact this widely anticipated event had on mortgage rates had already occurred well before the meeting.

The Federal Reserve targets two interest rates. One is the discount rate, which is the rate banks pay the Federal Reserve when they borrow. This rate is administered by the Fed and is wholly under its control. The second is the Federal Funds rate, which is the rate that banks charge each other on overnight loans. While the Fed does not administer this rate, it can control it by buying and selling securities, termed "open market operations". The Fed dropped both rates by ½ percent at the March 20 meeting.

But these rates are only loosely related to rates on bonds and mortgages. This is evident from what happened to the Treasury 10-year bond rate during the week that straddled the March 20 meeting, as illustrated below. The rate hardly moved at all during this period.

Date in 2001 10-Year Treasury Yield
Friday, March 16 4.78%
Monday, March 19 4.82
Tuesday, March 20 – Meeting Date 4.78
Wednesday, March 21 4.77
Thursday, March 22 4.73
Friday, March 23 4.80

In developing your lock strategy, therefore, forget about trying to guess the direction of interest rates. The first thing to consider is your capacity to take the risk of a rise in market rates. If you barely qualify at today’s rates and an increase would knock you out of the market, or force you to accept other unfavorable terms, you should lock immediately.

Pros and Cons of Delaying a Lock

If you can withstand a rise in rates, there is a benefit in delaying the lock. If market interest rates don’t change, the lock price falls as the lock period shortens. For example, a lender may quote a price of 7% plus 1.5 points on a 60-day lock and 7% plus 1.25 points on a 30-day lock. (One point is 1% of the loan amount). The reason is that the lender takes less risk with a shorter lock.

Working in the other direction, however, is that you lose the ability to walk away from your loan provider as the closing date approaches. This would not be a problem if the loan provider spelled out in advance exactly how the market price is determined on the day you lock. For most loan providers, however, the market price on the day you lock is what they say it is. If you don't have the time to make a switch, you are at their mercy.

You are safe in delaying a lock if you are dealing with a certified network lender (CNL) on this site because you can monitor your price every day. See Finding a Mortgage on the Professor's Certified Lender Network. You are also safe if you are dealing with an Upfront Mortgage Broker (UMBs) because she will give you the best wholesale price on the lock day and show you the price sheets.

On a purchase transaction, therefore, with the exceptions noted in the preceding paragraph, I would lock while there was still time to change loan providers. On a refinance, you can always change loan providers, so it’s safer to delay the lock until shortly before closing. The loan provider, however, should be made to understand that you understand how the game is played.

Also read Should You Lock ASAP?
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