Mortgage fraud abounds. Mortgage fraud abounds.

Tuesday, December 30, 2008

More on Discount Fees and Mortgage Pricing


In addition to understanding pricing options, it would be also good idea to keep a few additional things in mind when it comes to discount and rebate pricing.

I NEVER, EVER recommend paying a discount fee to buy a lower interest rate to reduce monthly payments. Again, the average family moves or refinances every 3-5 years. The reduction in monthly payments will not, therefore, save you any money until you have first recovered the cost of any discount fee and that normally takes 36-54 months.

For most, therefore, the anticipated savings is really nothing more than an illusion. You can, of course, ignore this and buy a lower than par rate but I don’t think it’s a wise decision. Besides that there is absolutely no way for you to know if the discount you are paying to lower your interest rate is actually being used to buy a lower rate. In extreme cases loan officers working for direct lenders and brokers have been known to charge discount fees without delivering a rate below market. Instead they deliver par or worse yet, a rate that also generates a rebate.

An underwriter will NEVER condition a loan approval on your willingness to accept an interest rate that generates a rebate. Rebate pricing has absolutely nothing to do with the loan approval process. It is an elective pricing practice driven by loan officers interested in generating additional income and/or consumers interested in using a rebate to reduce their out-of-pocket closing expenses.

To provide a little perspective here, some loan officers will try to convince you that a boost in the agreed upon rate with a statement something akin to the following:

“I’ve good good news and bad news. The good news is that your loan has been approved. Congratulations. The bad news is that since you had a bankruptcy ten years ago, had two or three mortgage lates, or a number of late payments on credit cards the underwriter has levied a requirement that you accept a higher rate (or pay a discount fee of XX).”

When you hear this it should raise a red flag. Remember, an underwriter may condition a loan approval on your willingness to accept a slightly higher rate at a slightly higher cost but those underwriting conditions NEVER result in a rebate.

An underwriter may condition a loan approval on your willingness to accept a higher interest rate or an add-on in the form of a discount fee, but again such conditions NEVER result in a rebate. Add-ons are legitimate costs the secondary market levies on loans that have proven to pose a greater risk for default, e.g., investor properties, a non-conforming property, loans of high loan-to-value, and loans to borrowers who have marginal credit.

If you are, therefore, told by a broker that the direct lender’s underwriter requires you to accept a higher rate for whatever reason, ask him if that rate will generate a rebate. If it does, then the adjustment in price has nothing to do with meeting an underwriting condition and everything to do with the broker’s desire to generate additional income. If told the rate offered will result in a rebate, let the broker know that the adjustment is unacceptable. If he insists this isn’t the case, tell him you will be taking your business elsewhere. If he balks at this threat, find a different broker. (Keep in mind that if you are dealing with a direct lender you will never know if the loan officer is telling you the truth or not because any rebate (overage) generated by an increased rate will never be disclosed on your closing documents.)

There is one other instance where a discount fee is justified and that’s if you want to lock your loan to guarantee delivery at the specified rate. The charge really isn’t a discount fee at all but while the entry of this fee on your Good Faith Estimate may appear as a separate line entry, sometimes it is entered as a discount.

To lock-in a rate, the direct lender your broker intends to submit your loan to must buy a forward commitment and in doing so they incur a cost. The cost will vary depending on the length of the lock-in period. No lock-in fee is required for immediate delivery which is normally 14 days prior to closing. A 30 day lock will normally run around ¼ point; a sixty day lock – ½ point.

Note: There are two exceptions to these guidelines that relate to the purchase and/or refinance of investor properties and second homes. Historically, investor mortgages experience a higher default rate than those used to purchase or refinance one's primary residence so you will more than likely be required to pay upwards of one and one half discount points to secure such a mortgage on an investment property.

Since the subprime mortgage meltdown, lenders have also been leary about loaning money on second homes because some borrowers have subsequently defaulted on the loans against their primary residences. As a result, I wouldn't be surprised if in the very near future lenders suspend the origination of second home loans altogether. At the very least if you're looking for second home financing, I suspect you'll have to pay a hard discount point or two that is passed onto the secondary market to offset their risk.