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The Ins And Outs Of Locking In A Mortgage Rate

By Brian Jenkins
The mortgage interest rates you are offered will be one of the primary ways you will determine which mortgage lender to use when you purchase a home. When you are quoted a rate, most mortgage lenders are actually giving you what is called an adjustable interest rate, which means it can change over time. So how can you lock in a mortgage rate, rather than fall prey to the changing economy? (continued below)

The Ins And Outs Of Locking In A Mortgage Rate

What does Adjustable Mean?

Most interest rates are adjustable, not fixed. That means that the mortgage rate you locked in when you signed your mortgage contract is not necessarily going to stay the same over the life of the loan. There are a number of different things you want to look at when you originally agree to an adjustable mortgage rate, or AMR:

The Initial Rate: This is the starting point for your interest rate
The Adjustment Period: This is how often the rate will change and the monthly payment amount will be recalculated
The Margin: This is the number of percentage points added to the interest rate in your specific case, and it should not change over time. (more on margins below)
Rate Caps: Your mortgage lender caps the amount the AMR can change over a certain period of time and over the entire life of the loan (more on rate caps below)

Basically, mortgage lenders use an index to come up with an initial interest rate. A margin is then added, based on your credit and other factors (for example, you might be paying index + 1%). As that index fluctuates, so will your interest rate.

Caps on Interest Rates

Never sign a mortgage agreement with an adjustable interest rate if there is no clause about caps. With an interest rate cap, your lender is free to change your interest rate whenever they want to make more money, which is not fair to you. There should be two caps specified. The first should be a cap on how much the interest rate can rise over the course of a short period of time (usually between one and five years). The second, higher cap should limit how much the interest rate can rise over the entire life of the loan. Some caps specify the percentage points an interest rate can rise, while others specify how much your total monthly mortgage payments can rise. Either is fine just make sure your contract has such a clause.

How can you get a Fixed Interest Rate?

Adjustable interest rates are not your only option in the mortgage world. The opposite of this kind of interest rate is the fixed interest rate, which is, as the name implies, an interest rate that is locked in and does not change. Fixed interest rates are not tied to any kind of index, though an index may be used to determine your rate initially. The advantage to locking in your interest rate is that you know exactly how much you will owe every month on your mortgage, and it will never change unless you refinance. Will you save money with a fixed mortgage rate? Maybe, but that is not always the case. Initially, fixed rates are usually much higher than adjustable rates, since the mortgage lender is compensating for the indexs rise that is certain to happen over the life of the loan. However, if the index does jump high, you will be saving money, since your interest rate will still be low.

Prepayment Penalties

Whether or not you lock in a rate, your mortgage agreement will likely have a prepayment penalty clause. When you have a fixed rate, this is likely a flat fee, while if your rate is adjustable; it may be calculated based on the index.

Essentially, a prepayment penalty is a fee that you have to pay to a lender if you pay off your loan early. Usually, this only applies to people who pay off the mortgage extremely earlier, not people who pay it off a month or two ahead of schedule. Lenders make money through interest, so if you pay off the principle of the loan early, you are avoiding paying the rest of the interest that would have compiled. When you have a fixed interest rate, you will likely be responsible for a penalty that covers a percentage of the interest you would have had left. If your rate is adjustable, the penalty could be calculated based on the current index, based on your initial interest rate, or based on a combination of factors.

About The Author
Brian Jenkins is a freelance writer who writes about mortgages and home ownership, offering tips such as how to find the lowest mortgage rates.