Most choose rate locks over discount points -- Page 2

The math is straightforward. What is the nonrefundable rate-lock fee and what is the rate cap? If you floated, and spent the money instead on discount points, how much would you be able to lower the rate? How high would rates have to rise in order for the discount points to be a bad deal? Finally, do you think rates will rise that much? If not, go with the discount points.

Buyers tend not to calculate things that way. They figure out what monthly payment they would be comfortable with, and lock accordingly. Such is the case with Clay Tingley, whose home is under construction in Danville, Calif. It is supposed to be finished in September. In February, Tingley got a 270-day lock through his builder's in-house mortgage broker. The fee was a quarter point, or $2,500 on a $1 million loan (it's California, after all).

His 5/1 adjustable-rate mortgage will have a maximum rate of 5.75 percent. He can float down once within 60 days of closing. He calls 5.75 percent his "comfort level threshold" or "affordability threshold."

"At 6 percent on my mortgage, I would feel uncomfortable with my monthly payments and begin to feel that the house was no longer affordable for me," he says. By locking far in advance, he adds, "I can sleep easier over the next five months."

Tingley didn't ask the lender what deal he would get if he paid the $2,500 to buy down the rate. Most likely, he would have been told that the minimum discount fee would be a half point or a full point.

Some lenders offer refundable rate-lock fees. You pay the fee upfront and it's credited to your closing costs as long as you stick with that lender. That's the deal that Wells Fargo offered Dave Demaree and his fiancee. In April they paid a 1-percent fee to lock the rate for 270 days. "Given the peace of mind we are getting with a locked-in rate, and the fact that we are in essence purchasing it with a deposit that we get back at closing, that's well worth it to us," Demaree says.

They could float, then pay one discount point ($1,800) later that would lower their rate by one-eighth or one-quarter of a percentage point. But Demaree would worry about rising rates in the meantime. The rate lock eliminates that worry.

A rate lock, then, is about psychology -- about alleviating anxiety. "I know a lot of people who would be happier to pay a higher rate and know that that's one thing that won't change before they move in," says Diane Saatchi, senior vice president of the Corcoran Group, which sells high-end real estate.

There's nothing wrong with that mindset, although a more hard-headed borrower might dismiss it. Someone such as Alex Beard, who recently had a home built in the Dallas area.

"I came to see -- and am now more convinced than ever -- that it simply makes no sense to pay to lock way in advance," Beard says. "People who do so are just freaking out about the prospects of higher rates, when logic should tell them to just play it cool and keep an eye on rates."

The way Beard figures it, five things can happen to mortgage rates when you are waiting for your home to be built. They can drop substantially, fall a little, stay about the same, rise slightly or skyrocket. In the first four of those possibilities, it makes more financial sense to spend money on discount points than on a rate lock.

Even if rates do skyrocket, "you can still pay down the rate and get the tax deduction for paying the points, whereas you get no such benefit from paying to lock way in advance," Beard says. "You'll probably end up where you would have been had you locked way in advance, so you're really no worse for the wear."

That may be true if rates don't jump skyward. But they could, and that's a scary prospect. "Ninety-five percent of all financial decisions people make are rooted in emotion," says Bob Walters, chief economist for Quicken Loans. "When people lock an interest rate, it takes away an unknown. And people hate unknowns."

Walters' advice? Shop around. Builders pressure borrowers into using their affiliated lenders, but it's a good idea to apply at a couple of other places, too. Some lenders "dramatically misprice" rate locks, he says, and you might as well take advantage of them if the rest of the deal looks good.