Mortgage Shopping Tips

Understanding Mortgage Loan Rates and Fees

When shopping for a mortgage loan, it's crucial to understand the various components of a Rate and Fee Quote to make an informed decision. Here’s a breakdown of the key elements:

1. Premium Rates

• Definition: A Premium Rate is any interest rate that is higher than the market’s Par Rate. The Par Rate is the base interest rate that lenders use as a benchmark for quoting rates.

• Example: If the Par Rate is 6.00%, and a lender offers you a rate of 6.25%, the extra 0.25% is considered a premium rate. Lenders earn revenue from this premium, which compensates them for offering you a rate above the Par Rate.

2. Lender Fees

• Types of Fees: Lender fees are charges for services provided directly by the lender. These may include:

  • Processing Fees: Charges for handling the loan application and documentation.

  • Underwriting Fees: Costs for evaluating and approving the loan.

  • Origination Fees: Fees for initiating and setting up the loan.

• Purpose: These fees help offset the lender's costs for processing, closing, and funding the mortgage loan.

3. Discount Points

• Definition: Discount Points are upfront fees paid to lower the interest rate on your mortgage. One point equals 1% of the loan amount.

• Example: For a $350,000 loan, paying 2 Discount Points would cost $7,000 (2% of $350,000). This payment typically results in a lower interest rate compared to the Par Rate.

• Benefit: Discount Points are used to reduce the interest rate, leading to lower monthly payments over the life of the loan. They are also tax-deductible in the year they are paid.

Factors to Consider

1. Duration of the Loan

   • Long-Term: If you plan to stay in your home and keep the mortgage for many years, paying points to lower your rate can be beneficial. This is because you will enjoy the lower rate for a longer period, making the upfront cost more economical in the long run.

   • Short-Term: If you anticipate moving or refinancing within a few years, it might not make sense to pay points. In this case, paying a higher rate with no points could be more cost-effective since you won't benefit from the lower rate for long.

   Example: If you plan to stay in the loan for 5 years and pay 1 Discount Point on a $350,000 loan, the upfront cost will be $3,500. This will save you $88 a month. After 40 months, the savings will cover the upfront cost, and you'll benefit from additional savings if you stay longer. Over a 10-year period, you could save an additional $7,060 in interest.

2. Opportunity Cost

   • Alternative Uses: Consider what else you could do with the money if you didn’t use it to pay points. If you have high-interest debt or other investments that offer better returns, it might be wiser to use the funds elsewhere.

   • Investment Perspective: Treat the payment of points as an investment. Calculate the return based on how long you plan to stay in your home and compare it to other potential uses of the money.

Conclusion

Understanding the components of your mortgage quote and evaluating your financial situation will help you make the best decision. Determine your long-term plans, assess the value of paying points versus the upfront costs, and consider alternative uses for your money. By taking these factors into account, you can optimize your mortgage strategy and make informed choices that align with your financial goals.