Right now, with mortgage rates at historic lows, it’s unlikely that you’ll hear of anyone choosing to float their mortgage rate. After all, most people will want to lock in the low rate now to protect themselves against the market recovery that will certainly mean higher interest rates.
However, this begs the question: when is floating a mortgage rate a good idea? Is there ever a time when it makes better financial sense to float rather than lock your rate?
The Difference Between Locking and Floating
Each of these choices presents a risk to the borrower. Locking in a rate means that you’re insulated against interest spikes, meaning the lender takes on the risk of rising rates. However, if the rates go down further, the buyer loses out and ends up paying more interest over the life of the loan.
Floating reverses those risks. If the rates rise, the borrower will have to pay more and the lender will see more revenue from them. But when rates fall, the borrower gets the benefit and will pay less in interest.
Over an entire 15 to 30 year loan, the savings that a borrower will see — either by locking or by floating — could be significant. But since very few people actually stay with the same mortgage over that time, those savings are much less impressive.
When Floating Makes Sense
If rates are relatively high, floating can make economic sense. For example, if you purchased a home in the late 90s, rates were hovering in the 7-9% range. While it would have been next to impossible to predict that rates would be under 4% in just a little over a decade, any borrower who floated his rate at the time would be sitting pretty right now.
However, choosing to float your rate, even when rates are fairly high, takes someone with a strong stomach — not to mention a hard look at your ability to pay a potentially higher rate. If you can barely afford your mortgage payment at the quoted rate, then floating your mortgage could really bite you if rates go up.
Refinancing As an Alternative
You can lock in your rate and still take advantage of falling rates down the road by judicious use of refinancing. It’s unlikely that many of the borrowers who took out a home loan in the late 90s are still paying 8%. Instead, they probably refinanced their mortgage when rates started hitting historic lows. While refinancing does mean you have to pay closing costs, it still tends to be a winning proposition, provided you stay in the home past your break-even point.
Tiny Rate Differences Don’t Matter a Great Deal
Some borrowers may see dollar signs in their eyes right now, thinking that an already low rate can surely go lower. But if current rates for a 30-year loan are at 3.75% (or thereabouts), the amount that you would save by a quarter or a half percentage point dip is very little.
For example, my husband and I shopped around for the best possible rate when we bought our house in 2010, finding an online bank that offered us a quarter of a percentage point better rate than any other lender. Working with this remote bank was a nightmare, however, and we regretted choosing them many times during underwriting and closing. Then, once we’d closed, we realized that the quarter of a percentage point saved us only $30 per month over the 15-year life of our loan. That tiny savings — even though it works out to $5,400 over the life of the loan — was certainly not worth the headache.
The Bottom Line
If you’re thinking of floating your mortgage now, because you think an historic low could possibly get even lower, do the math ahead of time. Figure out how much you’d save with each percentage point reduction, compared to how much you’d have to spend with each percentage point it could go up. For most people, it’ll make more sense to simply lock it and forget it.
Do you have a floating mortgage?