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In general, the lowest mortgage rates come with the highest processing fees. That said, mortgage rates and costs vary widely between lenders for the same loan to the same borrower.
- “Origination” fees usually cover the lender’s costs to process, underwrite and fund your loan
- “Discount” fees or points are extra amounts that you can choose to pay if you want a lower rate
- “Rebates” are fees that are paid by the lender to the borrower for accepting a higher interest rate. You can use rebates to cover other closing costs
The best combination of interest rate and fees depends on a few factors, and everyone’s “sweet spot” is probably a little different.
Mortgage rates: the bottom line
Mortgage rates are the number one issue when it comes to real estate financing. Sometimes that means processing fees are overlooked, fees that can substantially impact the real cost of mortgage loans. Why? Because different lenders make different deals.
To get the best deal, you have to understand the lender’s rate sheet. There’s not just one rate. Every mortgage has combinations of points and rates. If you qualify for financing at 4.5 percent, you might also be able to get the same loan for 3.875 percent or 5.125 percent. In some cases, you might actually want the higher rate!
An “origination” fee is the money you pay for the lender’s services. This processing fee is usually equal to 1 percent of the mortgage amount. If you borrow $150,000, the typical origination fee is $1,500.
Sometimes the origination fee will be higher if the lender must do more work.
This is the case with a standard FHA 203(k) financing. This is a type of mortgage that can be used to both buy a home and then finance major improvements. Because the program is so complicated, the government allows FHA lenders to charge a “supplemental” origination fee.
If the price of an origination fee seems high, consider that it costs a lot of money to create a mortgage. The Mortgage Bankers Association says that in the first quarter of 2018 the typical mortgage cost $8,957 to originate.
Processing fees and discounts
A “point” is equal to 1 percent of the mortgage amount. If you borrow $150,000, the cost of one point is $1,500. A “point” can also be called a “discount” fee and sometimes even a “rate adjustment factor.”
While origination fees are set in stone, points are negotiable. This is VERY IMPORTANT. You can change your interest rate by paying more points or fewer points.
The Consumer Financial Protection Bureau (CFPB) offers this example.
Let’s say you borrow $180,000. The interest rate is 5 percent with 0 points. When a loan is quoted with zero points you are seeing the “par” price.
But instead of zero points, you’re willing to pay .375 points. That’s 3/8ths of a point. In the case of a $180,000 loan that’s an additional $675, you must pay at closing. Now, the lender will offer the loan at 4.875 percent in the CFPB example. Your rate has gone DOWN.
Working from the CFPB model, the lender’s rate sheet might show several pricing options for a $180,000 mortgage.
- 5.375 percent means the lender will pay $2,025 in closing costs
- 5.25 percent means the lender will pay $1,350 in closing costs
- 5.125 percent means the lender will pay $625 in closing costs
- 5.00 percent plus 0 points equal par pricing
- 4.875 percent plus .375 points (you pay an additional $675)
- 4.75 percent plus .750 points (you pay an additional $1,350)
- 4.625 percent plus 1.125 points (you pay an additional $2,025)
Which combination of rates and points will you choose? It depends on your needs and preferences. If cash is a problem but monthly income is strong, a higher rate might be your best choice. If you have lots of cash, buying down the rate can be a good strategy if you expect to be a long-term owner.
To better understand your options, it’s best to run the numbers.
A $180,000 mortgage at 5 percent over 30 years has a monthly cost for principal and interest of $966.28. If you pay $675 extra at closing, the rate will fall to 4.875 percent. The monthly cost will drop to $952.57. You will save $13.71 a month. Divide $675 by $13.71 and in basic terms, you will need 50 months to recover your cost.
If you live in the property for more than 50 months, you’ll save money with the lower rate.
If you look at our model rate chart, you can see that it suggests an exchange. You can pay more cash up front to get a lower-than-par mortgage rate. If you can accept a higher rate, the lender will pay you.
A “rebate” is simply a situation in which, for a higher rate, you get a closing credit from the lender. The higher the rate, the more cash you can get to close. This can be attractive if you expect to be a short-term owner.
Different lenders will have different rate sheets. Lender Smith will have one set of rate discounts or rebates. Lender Jones will have another set of discounts and rebates. It pays to shop around for the best deal.
One approach is to determine what rate you want and get lender cost quotes based on that rate. So the lowest-costing option wins. Alternatively, you can set what you’re willing to pay and get rate quotes based on that cost. In that case, the lowest rate wins.