With treasury yields and the other indexes that make up the basis for many commercial real estate loans at recent lows, it’s time we have a chat about the rate lock. This seemingly simple concept is fraught with half-truths, mistaken expectations, and gotchas. Here’s a brief guide:
1. What is a rate lock?
A rate lock is a method of securing some degree of certainty that a desired fixed interest rate is the fixed interest rate that is baked into the loan documents at closing some 30-90 days away (or more, see “Forward Rate Lock” for how lenders can extend it out).
2. When can I lock my rate?
This varies by lender and loan type. Some banks and life companies will allow you to rate lock right at application or very shortly thereafter upon request, sometimes requiring a “rate lock deposit” or “rate lock fee” to lock it in. Others don’t allow you to lock the rate until the lender issues a loan commitment or even as late as 24 hours prior to closing, which can mean stressfully awaiting appraisers, underwriting folks, lawyers and title companies, etc. to do their jobs before that certainty is available. If a given interest rate achieves the necessary economic goals of a given investment, better to lock it in, and try not to think about what happens if rates fall.
3. Deposits vs. Fees
A rate lock deposit is just that, a deposit that is partially or fully-refundable at the closing of the loan. The idea is if the lender is taking on the interest rate risk by allowing a borrower to lock weeks before closing, they ought to have some security that the borrower intends to close the loan. A rate lock deposit would typically be non-refundable should the borrower cancel the loan because they opted to jump to another lender, while most lenders will refund it in full if the borrower simply cancels because they no longer need or desire a loan at all. Note that a rate lock deposit can be included with a “good faith deposit” or could be required separately.
A rate lock fee is a fee that allows a borrower to lock their rate but that fee is not refunded at closing.
4. “Forward” Rate Lock
This term denotes a rate lock that extends beyond the typical 60-90 days offered by most lenders. Some life companies, for example, can offer a borrower the ability to lock their interest rate today, but fund the loan at some distant date, sometimes even up to 12 months or more into the future. This is particularly useful for those borrowers refinance an existing loan that has a prepay penalty that will burn down closer to maturity, but that want to eliminate the risk that interest rates may change in that time period.
5. 3rd Party Rate Lock
Rate locks are also available via third-party companies such as through financial instruments offered by the likes of Chatham Financial and many others. These are effectively buying an insurance policy via swap or hedge product that allows you to lock in the rate for a specified period of time. These instruments are often pricey and are not for the average investor.
6. Finally… When should I lock my rate?
This one takes a little science and a lot of luck. Without a rate lock, a given interest rate will “float” with the currents of the market until loan docs are executed and recorded. Interest rate behaviors can be grossly predicted whether they will trend up or trend down depending on the time of year, current lender appetite for a given loan, and macroeconomic factors such as the economic cycle and global economic news. But finding precisely the best time to lock an interest rate really depends on too many factors to opine about here, and it’s really like asking the question “which shade of blue is best.”
A rate lock ought to be one factor among many within the business decision that is a properly-structured loan (loan amount, amortization, recourse, covenants, etc).
As with all investment matters, a proper advisor is worth their weight in fees.