considered recurring closing costs and are also part of the expenses associated with a home loan. For a complete list of all fees associated with your mortgage, please request a copy of your Loan Estimate (LE) from your mortgage provider.)
Separate from the above mentioned fees for services, taxes and daily interest is the cost associated with your actual interest rate itself. This cost, which can sometimes come in the form of a rebate, we call your rate pricing.
Most borrowers are already aware of the concept of "buying down" their interest rate. Depending on market conditions, you could pay 0.5%, 1.0% or even 2.0% extra (what are typically referred to as "points"), in order to obtain a lower interest rate. However, just the opposite is also true. Instead of paying extra money to get a lower rate, if you take a slightly higher rate, you can actually get some money back to pay toward your closing costs.
Hypothetical example of rate pricing options:
To give you an idea of how the cost / lender credit associated with a mortgage rate might look like, let's use a hypothetical loan amount of $400,000. (Your actual pricing will depend on your specific loan parameters, fico score, loan to value, loan amount, loan term, as well as current market conditions. Please contact your mortgage provider to obtain your personalized rate pricing for your specific lending needs.)
$400,000 Loan Amount used to calculate hypothetical cost or credit to borrower:
3.000% • 1.375% points ($5,500 cost to borrower)
3.125% • 0.750% points ($3,000 cost to borrower)
3.250% • 0.000% 0 points aka par pricing (no added cost to get this rate & no cash back)
3.375% • -1.125% lender credit ($4,500 cash back to borrower)
Most Loan Officers and savvy borrowers like to begin with what is called par pricing as a good starting point to then analyze the cost / benefit of taking either a higher or lower rate. Par pricing is also commonly referred to as a 0 point loan. There is no added cost to get this rate, (you are not paying any points to buy down the rate) but there is also no lender credit associated with the rate either. In our example above, a borrower can then contemplate if it's better to buy down the rate, stay at par, or take the higher rate and make use of the lender credit.
It's important to point out that your mortgage provider will only allow lender credit / cash back to cover your recurring and non-recurring closing costs. They will not allow you to actually pocket any lender credit that is left over after having paid all of your loan expenses. If your lender credit ends up exceeding your actual closing costs, then you will be required to select a lower interest rate to reduce the amount of lender credit until it is equal to, or less than, your actual closing cost amount.
Often times, a daily rate sheet will not have a perfect par price / 0 point loan. You will then have to settle for the closest par price available as your starting point. It could be either 0.125% or 0.250%, and it may be at a cost, or lender credit, all depending on current market conditions. Additionally, pricing is constantly changing, sometimes several times during a single day if the market is particularly volatile. The cost and rebate options available to you might be much closer together in price, like so:
3.000% • 0.500% points ($2,000 cost to borrower)
3.125% • 0.375% points ($1,500 cost to borrower)
3.250% • 0.250% points ($1,000 cost to borrower)
3.375% • -0.125% lender credit ($500 cash back to borrower)
How do I know which option is right for me?
Most borrowers might simply go with the 0 points option. (Or as close to 0 points as possible. In our example above, the rate closest to zero would be 3.375% at a rebate of 0.125%.) However, in this particular example, it might make more sense to pay the extra $1000 to buy down the rate, especially if there is a good possibility that you would be keeping this mortgage for the long term. It all depends on your particular lending needs.
The following are a few examples of when taking the lender credit could be beneficial.
Multiple refinancing: Many of our clients have refinanced twice, three time, or even four times. If you were to refinance at the beginning of the year, and decided to refinance again at the end of the year, you have just doubled your refinance expenses. It might have made sense to pay $3000 in closing costs to refinance once, however, it might not be as beneficial to pay $6000 to refinance twice within a 1 year period. If you suspect you might be refinancing more than once within a short period of time, it might be beneficial to have your lender cover the costs by selecting enough lender credit to pay for all of your loan expenses.
Moving or selling the property within the next couple of years: Again, it all comes down to the math. If you finance a property, (or refinance), but you know for certain that you will only keep the loan open for a short period of time, it might make more sense to take the higher lender credit. If over two years, the lower rate will save you around $1500, but will cost you $3000 in loan fees, you'll be out $1500. So it would be better to take the lender credit. (However, if there is at least some chance you might be keeping the loan long term, it's not worth it to try to save an extra $1500. In that case, it might make more sense to go with the lower rate and higher fees.)
Short on cash: Although we don't recommend someone apply for a mortgage if their finances are precarious, some cash strapped borrowers have found it beneficial to use the lender credit to pay for their closing costs, rather than use the money from their savings. This is especially helpful when purchasing a fixer where someone might be over budget due to unexpected home repairs.
Still not sure what to do: Contact us. We'll be happy to run the numbers for you and provide you with all the information you need to make a wise decision.