cost of home loan

Now a great time to refinance or buy a new home. There are many mortgage offers available right now, some with 30-year rates under 3%! Some lenders are even offering to contribute to the closing costs; others provide better rates than their competitors. So what do you need to know about all this?

What is a Par Rate?

You can take advantage of these low rates by participating in Par rates. In the lending business, an interest rate where investors purchase the loan from the mortgage’s lending entity is the Par rate. For a lender to make money to compensate the loan officer, the processor, the underwriter, and make a profit, you as the borrower would need to pay an origination fee.

Origination fees are expressed as “points” but generally equate to percentages. For example, if you spend 2 points to obtain a $200,000 loan, you will pay 2% or $4,000. Most borrowers do not want to pay that $4,000 out of their pocket and would like it included in the amount they borrow. Assuming the guidelines will allow the additional amount, the borrower would now be paying interest on $204,000 instead of $200,000 for the loan’s lifetime.

Cost of a Home LoanCost of Your Home Loan: How a No Points Loan Works

Many lenders will tell you they are not charging you any points for your loan. If they don’t charge you for the loan, they will not pay the loan officer, processor, underwriter, and others. So how do they get paid? Simply put, if they qualify you at a higher interest rate than the Par rate, investors will pay them more than the value of the mortgage itself to get the higher rate of interest or premium pricing.

For example, borrowing that $200,000 above at a rate of interest that is ¼% higher than Par, the investor might pay the lender $204,000 to acquire the mortgage. The borrower will pay ¼% additional interest on the entire loan amount for as long as they have the loan. The investor believes that the borrower will continue paying the loan long enough to recover the $4,000 extra they initially invested. They continue to receive the additional interest as their return. The borrower sees only the $200,000 repaid, but the payments are higher because the interest rate is higher.

Money Towards Your Closing Costs

Now take a lender that offers an additional $2,000 towards your closing costs. Either you must pay them in an origination fee; that is, out-of-pocket funds to cover that contribution. Or they need to increase their interest rate even further to cover both their origination costs and the contributions they will make toward the closing costs. Please understand that either way, the cost of the origination fee and the closing cost contribution are the borrower’s money, just paid over the length of the loan through higher monthly payments.

Where Do Closing Costs Go?

Every borrower must decide whether to define the costs, pay them in cash at closing, add them to the loan amount, or allow the lender to increase the rate to cover the expenses. Remember that many lenders “bake in” their origination costs, telling you they don’t charge points and quoting you a rate that provides them with the investor’s Premium. The amount of “baked in” fees directly affects how much the borrower pays over its lifetime and the cost of your home loan. Every borrower should ask their lender what the included premium is at their current rate. If there is no premium and no origination fee charge, ask the loan representative how much the lender is receiving for making the loan, and remember there is no free lunch!

cost of home loanChoose Your Lender Wisely

As you can see, determining what lender to work with is much more than what interest rate they provide, and can really affect the cost of your home loan. If they believe in the value they provide, having an open discussion about premiums, origination costs, and loan amounts should not be difficult. If it is, talk to another lender just to see how they compare. Remember, most loan originators, including bankers and online lenders, earn all or some of their compensation through loan amount and interest rate. Getting you the best interest rate and keeping the loan amount to a minimum is often not in the loan originator’s best interest; make sure you know what is!