Let’s say you are buying a house. Or maybe even refinancing your mortgage. Your mortgage broker has been magnificent. He explained the process, asked you about your goals, your level of comfort with various loan programs, reviewed your documentation and credit report with you. Even though it seems like he asked a lot of questions, he asks one more that you may not be sure about:
“We can buy down the rate. Would you like a lower mortgage rate?”
And you think to yourself, I’d like a lower mortgage rate like I’d like to wake up tomorrow.
This may sound like a trick question, but it’s not. You have a choice to make when selecting your mortgage interest rate. It’s important to understand how mortgage loan rates are priced and what options are available to you.
Of course, there may be parameters that need attention such that you may not qualify with the rate that costs the least or it may be necessary to buy the rate down to qualify based on other factors such as income, recurring monthly debt and the loan size.
Here are some rates and pricing from this past week for illustrative purposes only:
Most folks and even a few loan officers look at a chart like this and get blinky eyed. Keep in mind this is just the base pricing. It does not take into account loan-to-value and credit score, whether it is a condo or many other factors that may or may not apply. This is the reason there is no longer a single rate for any 30 year fixed mortgage.
This chart shows rates for borrower paid fees. There are options for lender paid where the mortgage broker receives their compensation directly from the lender. Let’s say your loan officer and you have agreed that you will pay his company 1.5% under the borrower paid option to arrange and close the purchase financing for your mortgage.
Let’s further assume you need a 30 day rate lock for a loan amount of $417,00 and the loan officer quotes you a rate of 4.375% and one and one half (1.50%) points. If you look at the chart you will see those two values, the 30 day lock and the 4.375% rate, intersect where it says (1.678). This means the lender will pay 1.678% for a closed loan delivered at that rate. The loan officer’s company will make $6,255 (417,000 * .015) and you will receive a lender credit in the amount of $6,997.26 (417,000 * 0.01678). You can not legally use that credit to cover the cost of the originator’s fee but it can be used to offset other closing costs such as title insurance or recording taxes. Just remember: it’s a net transaction.
Now, you hear the question that was asked above: do you want to buy down the rate? With this pricing if you went down in rate to 4.25% your lender credit would be lowered to (1.178). Lower rate, higher cost. That’s exactly a half point more in cost to lower the rate 1/8th in percentage. That is a very typical cost association: the cost for a difference of 1/8 in rate can typically be anywhere from 3/8 (0.375%) to 5/8 (0.625%).
But it depends! Look at the cost difference when you go below 4.25% down to 4.125%. The increased cost for that lower rate is more than 7/8th of a point. It is very common when you get to the lower edges of the pricing matrix that you will pay more for each incremental decrease in rate.
There is a risk premium and a market perception
Notice that the cost difference going from 5.00 to 5.125 is only a quarter of a point (0.25%). This shows that when you are higher in the interest rate tranches the incremental cost for a rate difference is typically smaller but not always. Look at the difference between 5.375% and 5.50%. The costs difference is that very familiar half point (0.50%). This might be termed an anomaly.
Another thought may have struck you: With rates available as low as 4.125% why would anyone be interested in a 5.75% rate? Quite honestly, few borrowers are. And yet for those that need a large lender credit to cover up front mortgage insurance, transfer taxes and/or owner’s title insurance these higher rates and larger lender rebates can be extremely useful and a downright necessity. These large lender credits are how zero point, zero closing cost loans are accomplished. For those that need to close now but feel rates could drop in the future, zero point and closing cost loans are an option.
You lock into more than one rate at a time.
One more reminder: if you lock in to any one rate/cost/time frame you have locked in to all of them in the same time frame. That can be important when an appraisal comes in lower than expected or there is a change in a previously negotiated seller credit.
In a future article we will analyze with numbers and calculations whether it makes sense to buy down your rate.