Loan Lock: What It Means And How It Works

What Is a Loan Lock?

A loan lock refers to a lender’s promise to offer a borrower a specified interest rate on a mortgage and to hold that rate for an agreed-upon period of time.

How a Loan Lock Works

A loan lock guarantees a borrower that a mortgage lender will, upon closing, provide a loan with a specified interest rate. Typically, lenders offer quotes to prospective borrowers that reflect prevailing interest rates at the time of the offer, rather than at the time of settlement. The quoted rate will also include a lender’s margin. Rates can go up or down prior to closing, so a loan lock provides the borrower with protection against a rise in interest rates during the lock period. A lender will sometimes offer a loan lock as a specific rate plus a number of points. Points represent a fee paid at the origination of a loan to receive a lower interest rate over the loan’s life.

If rates go down during the lock period, the borrower may have the option to withdraw from the agreement. The probability of such a withdrawal is known as a fallout risk for the lender. The borrower should take great care, however, to ensure that the lock agreement allows for withdrawal.

In some cases where prevailing rates decline during the lock period, the borrower may have the option to take advantage of a float-down provision to lock in a new, lower rate. As with any feature that increases interest-rate risk to the lender, a float-down provision will only be available at an additional cost to the borrower.

Loan locks generally last 30 or 60 days. At a minimum they should cover the period necessary for the lender to process the borrower’s loan application. An example of a short lock period is one that expires shortly after completion of the loan-approval process. In some cases this lock period can be as short as a few days. A borrower can negotiate the terms of a loan lock and often extend the term of the lock for a fee or slightly higher rate.

Loan Lock vs. Loan Commitment

It is worthwhile to distinguish between a loan lock and a loan commitment. A loan commitment can refer to a commercial line of credit, but when used in reference to a mortgage agreement the term refers to a lender’s intention to lend a certain amount at an unspecified point in the future. The commitment may or may not contain a loan lock. Generally, a borrower uses a lender’s commitment to make his or her offer more attractive to the seller of a property in a competitive bidding environment.