Stockbrokers and gamblers have in common the belief that while nobody can tell the future, gathering data is the next best thing. The more carefully and deeply we measure where we've been, the more accurately we think we can predict where we're going. Tell us the horse with the best odds, and we think we have glimpsed the future enough to make the smartest bet.

Last week, bettors at the 2021 Kentucky Derby got a thrilling two-minute lesson in how past results are no guarantee of future performance, as they say on Wall Street. None of the top three favorite horses finished first. Thrillingly, a horse with 15-to-1 odds, Medina Spirit, trotted off with the rose garland.

Homebuyers and refinancers take a gamble when they lock in a rate. After the lock, rates could drop. Lender wins!

On the other hand, locking in a low rate lets you freeze the good fortune of living during a time of record low rates, at least for a few weeks. If market fluctuations cause rates to climb, the borrower can rest assured that the lender will honor the lower rate. Borrower wins!

The Risk and Rewards of Rate Locking

You may be wondering, when rates are historically very low, why doesn't everyone lock in? Because locking often costs money, either up front or in the form of points, each point being 1% of the loan amount. This money offsets the lender's risk of letting borrowers lock in low rates. Instead of making money off higher interest, the lender makes money by selling rate locks.

For you to come out the winner in a rate lock, not only must the rate you locked be lower than the going rate at closing, but it must be sufficiently lower to cover the cost of buying the lock in the first place.

Now you see why we've used the gambling analogy. Rates going up or down is a binary variable, easy to get your head around. But factor in the cost of the lock and the decision gets trickier. Rates could be higher at closing time, but not high enough to make you the winner.

Let's say that your locked rate is 0.10% lower than the going rate at closing, an outcome that appears to work in your favor at first glance. An amortization table tells you that your lower rate saves you about $1,000 in cumulative interest. However, the lock cost half a point (0.5%), which works out to $1,113 on a $225,000 loan. The numbers are close and not worth getting upset about, but the fact is mathematically, you would have been better off not locking in the lower interest rate. Rates did climb, but they didn't climb high enough.

Sometimes you pay for the lock in the form of a higher rate. It seems counterintuitive that to lock in the lowest rate you can find, you actually agree to a higher rate, but the higher rate is how you pay for the lock.

“Almost all rate locks come with a fee and, if you need to extend the rate lock because of delays in settlement, there may be an additional fee. If a lender claims there is no fee, the truth is that it is baked into the mortgage rate offered.”

   —The Washington Post

Likewise, if you're willing to nudge up the rate a bit more, some lenders will add a float-down clause to your lock. What you get for your money is a one-time adjustment should rates drop significantly (0.375% or more) during your lock period.

Points are tax-deductible so long as you used the mortgage to buy your primary home. This lessens the net cost of locking in. Points on a refinance mortgage, however, are not tax-deductible.

How Should You Time a Rate Lock?

Most lenders only let you lock in a rate on a specific property, which means you can't lock the lowest rate that comes your way and then go shopping for a home to take advantage of it. There's a way to get around this, but it costs more money. A lender might offer you a lock-and-shop rate, but it's usually higher than the prevailing market rate. Plus, the lender may require a nonrefundable deposit on closing costs to discourage you from lender shopping while you're out home shopping.

You can lock in a rate anytime from application to close. The length of the lock is typically 10-60 days, but because COVID-19 was lengthening closing periods to an average of 58 days, we started to see lenders offering longer lock periods to match. Although the next report isn't out, closing wait times are generally reported to be improving as the new year rolls on.

Longer periods cost more, so you don't want to overpay, but you also don't want the lock to expire ahead of closing. Investopedia notes, "Certain lenders may offer a free rate lock for a specified amount of time but then charge fees for extending the lock."

Before deciding on a lock period, confirm that it will cover your expected closing date. Even with the best planning, closing dates can be pushed back. If closing should take longer than expected, many lenders will let you relock at the going rate or the original rate, usually for a fee.

Conclusion

When you consider that "locking in a low rate" actually means agreeing to pay slightly higher than the going rate to cover the cost of the lock, and perhaps slightly higher to add a float-down clause, and to pay a relock/extension fee if the lender says it's still working on your loan when the lock expires, and all the while you risk losing if rates drop again, then you can understand why locking is not the simple decision it first appears to be.