Shopping overview -> Loan pricing, points and credits

Loan pricing, points and credits

To effectively evaluate loan offers, and decide whether to pay
to lower your interest rate, it is necessary to understand loan pricing.

LOAN PRICING, POINTS AND CREDITS:

“What is today’s rate?”

Consumers, especially those who are getting a mortgage for the first time, often ask the lender “What is your rate today?”. A lender doesn’t have a single “rate”, but has, for each loan program offered, a pricing grid consisting of different rates at varying costs; these costs are often called ‘points’. A lower rate will have a lower payment, but the initial cost will be higher; opting for a higher rate may result not only in no cost or points for that rate, but instead a credit back to the borrower that can be used to defray other closing costs. For every rate on a lender’s pricing grid there is either a charge to the borrower, a credit back to the borrower, or neither (no-point pricing). Pricing is also affected by the length of a loan lock; the shorter the lock period, the lower the charge (or the bigger the credit) for a given rate. Examples below.

What are points?

Loan pricing often includes a charge for the interest rate that you choose. This charge has historically been expressed in ‘points’. For example, you may hear  “I can get you 4.50% at a half-a-point” or “We have a 30 year fixed at 3.99% with one point”. One ‘point’ is one percent of the loan amount, i.e. on a $400,000 loan one point would be $4,000, half-a-point would be $2000. In today’s loan market this pricing is often expressed in fine gradations, and the word ‘point’ may or may not be used. You may be offered a loan package that has a charge of .443 for a given rate; this charge may also be referred to as .443 points. Either way, this would be .443% of the loan amount.

Mortgage Pricing

Example: Let’s say that you want to refinance your current mortgage which has a balance of $400,000 into a new 30-year fixed; this is what a lender might see on his computer screen when quoting loan terms (highlights below added to illustrate following example):

Interest rate  15 day lock   30 day lock   45 day lock 
4.375% 2.376 2.543 2.755
4.500% 1.047 1.220 1.443
4.625% 0.347 0.524 0.759
4.750% -0.442 -0.264 -0.026
4.875% -1.121 -0.945 -0.707
5.000% -1.821 -1.646 -1.408

To the right of the interest rate column you see the charge of locking in a rate for 15, 30, or 45 days for the different interest rates listed on the left. These charges are a percentage of the loan amount, i.e. ‘1.443’ = 1.443% of, in this case, $400,000 or $5772. The positive numbers in the grid are a charges you would pay for a specific rate, the negative numbers are a credit you would receive back from the lender, which can be used to defray the closing costs of the loan.

If you wanted to lock in 4.50% for 45 days (which would have a monthly payment of $2027) you would pay to the lender 1.443% of the loan amount or $5772, plus all of the other closing costs. However, if you locked in at 4.875% (a monthly payment of $2117), you would get a credit back from the lender of .707% or $2828, enough to defray most of the closing costs of the refinance – although your monthly payment of $2117 at 4.875% would be $90 higher than the payment of $2027 at 4.50%. In other words, if you take the 4.875% rate and pay $90 a month more, you don’t have to pay the $5772 charge for the 4.50% rate, and you also get a credit of $2828 -  saving you $8600.00 in upfront closing costs.

 

New regulations mandate that a lender offer pricing that is clear to the borrower and cannot arbitrarily be changed during the approval process. Before this regulatory tightening, loan officers could negotiate very different loan terms and fees to equally qualified borrowers. This often resulted in some borrowers, often those less financially experienced, paying much higher rates and fees than others who were shopping at the same lender on the same day. This is no longer the case. However, even though the new rules make shopping for a mortgage simpler, it is still important for you to understand mortgage pricing in order to accurately compare loan offers, and decide on the right mortgage strategy for your situation.

Should you pay points?

The primary consideration when deciding between loan offers that have the same terms (i.e. 30 year fixed), but different interest rates and fees, is your estimate of how long you will keep the loan. In the example above, your mortgage payment would be $90 a month higher at 4.875% than at 4.50%, but you would be saving $8600.00 up front. It would take eight years before the $90 a month saving from the lower rate of 4.50% equaled the $8600.00 initial saving that you would receive at the higher rate. This means that if you you sell, refinance, or payoff the mortgage within eight years, you will lose money with the 4.50% interest rate, in spite of having a lower payment.

Deciding how long you will keep a loan is a difficult calculation for some people. No one can be certain what interest rates are going to do in the future, whether or not there will be a refinance opportunity, but some people believe they have a good idea and make their mortgage decision accordingly. Other people know they aren’t going to keep their loan because they don’t intend to keep their house due to a job transfer, downsizing, or for other reasons.

If you are financially conservative, and don’t have a clear timetable on how long you will hold on to your house, or think you will be in the house for a long time, the wisest course may be the middle road. Choose the interest rate that has very low or no charge or credit, the ‘no-point’ option. There are two reasons why this may be the right choice. If interest rates don’t come back down, you will be happy that you didn’t choose a higher interest rate in exchange for a closing cost credit that can end up costing you money over the very long term. And, if rates do fall, you haven’t paid a high loan charge for an interest rate that you could have later refinanced into at little or no cost.