Regardless of the mortgage type (conventional, FHA, or VA), mortgage product (fixed, adjustable, interest only, or balloon), or your credit rating, the rates available on any given market day fall into one of three categories: discounted rates, par rates, and premium rates. In Table 1 “Discounted Rates” appear in blue; the black rate represents “Par” or fair market rate, and those appearing in red represent “Premium Rates”. Keep in mind that the rates shown do not necessarily reflect the current market.
Note: You will have to double click on the table to make it large enough to read.
The “par rate” shown in Table 1 represents the prevailing market rate. Put another way, the par rate is that interest rate that does not require you to pay discount points AND does not generate a rebate. When a loan is priced at par, the broker’s profit is restricted to an origination fee. Some brokers may attempt to also collect a “broker fee” but there’s no legitimate reason to think that you are obligated to pay that. If he insists on it, find another broker. Brokers will also charge a processing and underwriting fee. These fees really don’t constitute a source of profit because the broker has to pay his processor and the underwriting fee is a fee that’s passed on to the direct lender’s underwriter.
The discounted rates shown in the table are those rates offered BELOW par (or the prevailing market rate). Discounted rates are accompanied by a discount fee. The lower the rate you buy below par (fair market), the greater the fee.
Discount fees are not by definition retained by the broker or the direct lender. They are passed to the investor who buys your loan. Why? No investor will be interested in buying a mortgage with a lower than par rate unless they are offered a financial inducement to buy it.
Unscrupulous lenders have been known, however, to charge a discount fee and not deliver a lower rate. Instead of passing the discount on to the investor, the lender retains the fee as an additional profit. Unfortunately, in some regions of the country, the practice is a common one so if you agree to pay discount points you aren’t going to have any way to determine whether they are legitimate or not.
The solution? Never agree to pay discount points to lower your interest rate.
The premium rates shown in the table are those rates offered ABOVE par (or the prevailing market rate). Like par and discounted rates, loans carrying premium rates are usually accompanied by an origination fee. What separates them from a par and discount rates, however, is that they generate a lender rebate.
What most consumers fail to understand is that the rebates generated by premium rates are, more often than not, pocketed by the lender as overage - an undisclosed or under-disclosed profit. Next to refusing to pay discount points to lower your rate, eliminating or controlling overage will be the key to your ultimate success in negotiating the best mortgage terms. If you don’t control this, you will end up with a higher interest rate which ultimately means that your monthly payment will be not only higher, but in some instance dramatically higher.
I use the term “under-disclosed” as it relates to broker pricing because the rebate shown on a Good Faith Estimate is all too often misrepresented as a issue the borrower doesn’t have to concern himself with.
Borrower: “What the hell is this?”
Broker: “Oh, that. You needn’t worry about that. This is what the lender pays us to generate your loan. You don’t’ have to pay it so don’t worry about it.”
Understand that no direct lender is going to offer a rebate unless the broker sells a rate higher than the market (par) interest rate. This, therefore, should be of concern to you because a higher interest rate will translate into higher monthly payments and, over time, this could prove to be exceedingly expensive. If the rebate appearing on your Good Faith is not going to be applied to your closing costs, it constitutes overage and will go into the loan officer’s pocket.
As mentioned in the previous section, if you deal with a direct lender, you will have no way of knowing if your loan officer is using premium pricing to generate overage because direct lenders are not obligated to disclose rebates generated by higher than par interest rates. Some direct lenders have an internal policy that prohibits a loan officer from pricing loans to generate overage but this doesn’t prevent the lender’s marketing department from doing the same thing.
Keep in mind that rate sheets are designed for loan officers and as such they only tell the loan officer what a particular rate, when sold, will cost or will generate in the way of a rebate at a specific point in time. The dollar amounts appearing in the Table 1 show what the discount fee and rebate would be on a $100,000 mortgage. If you are in the market for a larger mortgage, e.g., $200,000, $300,000, or $400,000, double, triple or quadruple the amount shown.
Depending on the volatility of the financial markets, it’s also important to understand that mortgage rates and the discount fees/rebates paired to those rates may change several times a day. Given this it’s important to understand that on any given day and at any given moment the lowest rate at the lowest cost will ALWAYS be the par rate. If you center your decision on that you’ll never have to concern yourself about the broker using market volatility to justify an illegitimate boost in your rate.
Update: Fannie Mae is apparently taking steps to boost the cost of higher risk loans. Specifically, I'm told it is now requiring borrowers with credit scores below 690 to pay upwards of 3.25 discount points to secure an interest only loan on condominiums and that's not the only stipulation. To get even that deal borrowers are being required to put at least 20% down. It's important to remember that this additional cost is not supposed to go into the brokers or direct lender's pocket. It's passed on to Fannie Mae who ultimately passes it on to the mortgage backed securities investor in the form of a deep discount.
This development should not be taken lightly because unscrupulous loan officers could easily misrepresent the facts. If a loan officer tells you that you're going to have to pay discount points for any reason, make him provide you with a copy of the page in the Fannie Mae, Freddie Mac, FHA, or VA Seller's Guide that states that you're obligated to pay them. If he/she can't produce that documentation, you'll know that he/she is trying to generate additional income.
