Understanding Rate Locks: Why Longer Locks Come with Higher Costs

When you apply for a mortgage, one of the most crucial decisions you'll face is locking in your interest rate. But why do longer rate locks tend to cost more? It all comes down to risk—both for you and the lender.

The Role of Interest Rate Fluctuations

Between the time you apply for a loan and the moment you close, interest rates will fluctuate. Sometimes, these changes are subtle, but they can also be quite volatile, even shifting from one minute to the next. Locking in your rate serves as a safeguard against rising rates, much like purchasing an insurance policy.

The Lender's Perspective: Risk Management

When you lock in your rate, you're effectively transferring the risk of rising rates to the lender. To manage this risk, lenders often purchase financial instruments called "hedges," such as U.S. Treasury Bonds, which move inversely to interest rates. However, these hedges come at a cost. The longer the lock period, the more expensive the hedge, which is reflected in the cost of your loan.

How Loan Type Influences Rate Lock Costs

The type of loan you're considering can also influence the cost of a rate lock. Some loans, like adjustable-rate mortgages (ARMs), are tied to indexes that move more slowly compared to the daily fluctuations in the broader market. This reduced volatility can result in lower costs for longer rate locks.

Making the Right Decision for You

Predicting interest rate movements is nearly impossible, which is why choosing the right rate lock duration often comes down to personal comfort. If the thought of fluctuating rates makes you uneasy, opting for a longer lock—even at a higher cost—might be worth the peace of mind. On the other hand, if you're comfortable with a bit of risk, a shorter lock could potentially save you money.

Whatever your choice, we're here to guide you through the process and ensure you feel confident every step of the way.