Getting caught on the wrong side of a rate lock
By Michael D. Larson • Bankrate.com

Consumers have a lot riding on their decision to lock in a mortage rate. Locks that don't last long enough or cost more than they should can drive up the price of a mortgage. And whenever rates bounce up and down, you had better know when to move.

Comerica economist David Littmann says the bottom line is this: "You want to secure rates that are relatively low by recent historical standards."

Most home shoppers understand the basic function of rate locks. They allow consumers to obtain rate and points commitments on their mortgages between the time of application and closing. By ending their "float" period, borrowers don't have to worry that a rise in market rates will make their financing more expensive.

A dangerous -- and costly -- assumption
Mortgage lenders and brokers usually offer short-term locks for free. As a result, many borrowers take the easy way out and assume they're covered. If rates move quickly, however, or if your closing takes longer than expected, a short-term lock can be hazardous to your finances.

Buyers of new homes will find their closing date will hinge on their contractors. They, in turn, are at the mercy of the labor market, the availability of the right construction materials and even the weather. Not surprisingly, the builders sometimes miss their scheduled delivery dates to home buyers, pushing mortgage closings beyond the 60-day rate lock periods that were supposed to be sufficient. Because new home contracts usually don't come with rate guarantees, borrowers in that situation end up paying the newer, higher market rate without any way to recoup the added cost.

Financial institutions don't always get done in time, either. The average home loan took 40 days to complete as of late October, according to a recent Bankrate.com survey of banks and thrifts in four major metropolitan markets. That means a basic lock, such as the 45-day version typically offered by mortgage brokers, might not offer consumers enough protection against rising rates.

Longer-term locks are available
What can home buyers do? For starters, they might want to consider longer-term locks. Most lenders offer commitments that go as far out as 90 or 180 days, and some companies will lock rates for up to a full year. As a general rule, the longer the lock term, the more it will cost the borrower and the less protection it will offer. But it may be better than being fully exposed to the whims of the market.

Mortgages designed specifically for the purchase of new homes are another option. The Norwest Mortgage division of Wells Fargo & Co. offers a program that allows new construction shoppers to get a one-year lock for free on certain adjustable rate mortgages.

"It's a win-win all the way around," says Dixon Sewell, a Norwest sales manager who works with builders in the Atlanta area.

Rates don't always rise, however, and many borrowers are comfortable floating their mortgage up to the last possible moment. That can be as little as a couple of days before closing. These consumers should be able to obtain loans for a little less money, since 15-day and 5-day lock loans don't cost the bank or mortgage broker as much to obtain from their funding sources.

Unfortunately, brokers often charge the 30- or 45-day price anyway because consumers don't know the difference, according to Jack Guttentag, a syndicated columnist who founded the Mortgage Professor Web site. Borrowers generally don't get stuck with higher rates on their loans that way, but they do end up shelling out a few hundred extra dollars in origination points or fees.

"When you elect to float, it's supposed to mean you get the benefit of a rate decline if one occurs between the time you elect the float and the time you finally lock just before the loan closes," Guttentag says.

Some brokers don't even offer loans with very short lock periods. That means customers who don't take the extra time to shop for brokers with a full range of products may pay more for their loans.

Locking rather than floating
Consumers should remember that locking in rather than floating could leave them with higher payments if rates decline. Ilich-Ernst got pre-approved for her mortgage months ago and kept floating because news about the market suggested rates would be fairly stable. But she missed at least a one-quarter of a percentage point decline and maybe more because she locked in a few days too soon.

At the same time, experts caution borrowers against kicking themselves if they wind up in the same situation. Rates can never get too low, they point out, but they can rise high enough to make a mortgage unaffordable. Locking in guarantees that you'll at least be able to buy a home, even if it costs a few extra bucks. Refinancing is always an option, too, if rates drop far enough later.