The mortgage industry is almost cruelly filled with nearly impossible jargon. Most of it is inconsequential from the consumer’s perspective and only serves to make communication easier for industry insiders. However, when it comes to the concept of choosing an interest rate from your lender par rate, buy ups, buy downs, discount points and lender credits are a must know.
Today’s Rate – “Today’s Rate” is a myth perpetrated as a reality. It is something the mortgage lending industry came up with because it’s an intellectually condescending industry that doesn’t believe that its clients can do math or understand complicated concepts (which is hogwash). There’s no such thing as today’s rate, only “today’s rates.” On any given day, at any given time, there are many rates with different costs from which a consumer can choose.
Par Rate – The Par Rate is not “Today’s Rate.” The Par Rate for mortgages is really a reference point only (and one that any borrower should insist on finding before making a rate decision). It represents the lenders offered interest rate that comes closest to having no Lender Credit, Discount Points or Origination Fees. Establishing the Par Rate is essential to making the eventual decision on which offered rate from the lender a borrower would like to lock in.
Buy Ups or Lender Credits – This is where a client takes a higher than Par Rate and the excess lender profitability is credited back to the client to be applied against other settlement charges (e.g. homeowner’s insurance, escrow accounts, government charges, interim interest and title charges). It is by using the Buy Up approach that lenders are able to offer “Low Cost” or “No Cost” loans (which is really a misnomer since the cost is really built into the rate).
Buy Downs or Discount Points – Technically, Discount points are a form of pre-paid interest but that’s a confusing way to look at it. One point equals one percent of the loan amount but discount points can also be surgically applied to reduce the rate using fractions of one point (i.e. 0.421%). By charging a borrower points, a lender effectively increases the yield on the loan above the amount of the Par Rate. Borrowers can elect to pay a lender points as a method to reduce the interest rate on the loan (typically in intervals of 0.125% to the rate), thus obtaining a sub-market rate and a lower monthly payment in exchange for this up-front payment. Discount points, as opposed to origination fees (i.e. origination fee, processing fee, underwriting fee, etc.) can sometimes have tax advantages as well. For more on that, click here.
Now let’s get to it. How do you choose your interest rate? Firstly, you need to insist on seeing “today’s rates” along with their associated costs vs. Today’s Rate (since we now know that’s not a real thing). After requesting the rates, here’s what one’s options might look like (for illustration purposes only):
When choosing your interest rate, several variables should be taken into consideration. First and foremost, if a purchase agreement includes seller paid closing costs, one has to remember this: if you don’t’ use them, you lose them. In other words, the sum of all non-financed settlement charges (origination fees, discount points, appraisal, credit report, title charges, government charges, escrow account, PMI premiums, homeowner’s insurance binder, etc.) must be equal to or greater than the amount of the seller paid closing costs. If they are less, the difference will just be credited back to the seller and that’s a dreadful lost benefit for a buyer. In short, maximize your discount points to get to the lowest rate using the entire allotted seller paid closing costs first. If you’re wondering whether or not you want your purchase agreement negotiated with seller paid closing costs or not, this calculator will show why it’s almost always the best way to go; click here.
After taking seller paid closing costs into account, should one want to put more money towards the rate in exchange for a lower rate, different cost benefit analysis should be taken into consideration. Taking the added cost to get the lower rate and dividing it by what would be the monthly payment savings can give a rudimentary break even point in terms of months. That can be an informative way to start but making a final decision on rate can be more complicated. The Time Value of Money can be taken into consideration. The tax deductibility of paying points can be a factor. How a choice between different types mortgage insurance can affect rate, payment and costs is often considered. Ultimately, it’s a personal choice at this point. None of these things can be weighed without the necessary information regarding an array of rates and costs and understanding how buy ups, lender credits, discount points and buy downs work. The most important thing is getting to the point where you have all of this information and then make an informed decision and this is the road to get there.
Charles Dailey – NMLS 79048 – Branch Manager, Loan Officer, Certified Military Housing Specialist
The Home Buyers Scouting Report® is provided directly to the buyer by HBM II, a licensed national real estate brokerage service company, not to or through a lender. The FREE home finding service is provided directly to prospective homebuyers by HBM II and its real estate brokers, as part of their ordinary real estate brokerage services. HBM II, Inc. works cooperatively with other real estate agents across the United States in attempting to find ready, willing and able buyers for homes listed for sale. The role of the Preferred Loan Officer is to assist in determining a comfortable home price range for Home Buyers Marketing II, Inc. (HBM II) to use when it is searching for property listings within the buyer’s search criteria.