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Most choose rate locks over discount points

Home builders and their customers -- the ones who wait months for construction to be completed -- crave the same thing: certainty. That explains the appeal of long-term rate locks.

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Uncertainty reigns over the home-construction process. Builder and buyer seldom know for sure when the house will be finished, and the final cost often is in doubt until late. And both sides worry about the impending storm clouds of rising interest rates, which can rain on the home-financing process.

It's no surprise that both sides shelter themselves from rising rates by making long-term rate locks. These rate caps are pushed by builders and embraced by buyers. But there's a riskier alternative: eschewing a rate lock and spending the money instead to get a lower rate. It's riskier because no one can predict if or when rates will skyrocket.

"It's impossible to tell which is going to be the best option for the borrower unless you're looking backwards," says Mark Dallal, vice president of secondary marketing for Homebuilders Financial Network, which operates in-house mortgage brokerages for home builders.

When choosing between a rate lock and discount points, borrowers don't have the benefit of hindsight.

A rate lock is the lender's promise that the mortgage's interest won't exceed a certain rate if the loan is closed by a deadline. For example, if you lock the rate at 6 percent 14 days before closing, and rates rise over the next two weeks, your loan's rate is 6 percent if you close on time. Meanwhile, someone who didn't lock -- who floated, in industry parlance -- would pay the higher rate.

Each lender handles rate locks differently. Most don't charge a fee to lock a rate within 30 days of the scheduled closing. Fees are common when the lock is beyond 30 days, and especially when it is beyond 60 days. The fees vary, and some lenders will refund all or part of the rate lock fee at closing.

Mortgages are like shaggy-haired car mechanics: long locks usually are covered by caps. If today's rate is 6 percent, a 180-day lock might cap the maximum rate at 6.5 percent instead of today's rate. A lot of long-term lock programs have a float-down option, which allows the borrower to seize and lock a lower rate shortly before closing if rates have dropped in the meantime.

Discount fees are more straightforward. The fees usually are expressed as points, where one point equals 1 percent of the loan amount. When you pay a discount point, the lender lowers the rate. The amount of the discount varies with the tides of the mortgage market, but one point usually lowers the interest rate by one-eighth to three-eighths of a percentage point. On purchase mortgages, discount points are deductible from federal income taxes. Rate lock fees are not tax-deductible.

-- Posted: April 21, 2005




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