Quoting a mortgage interest rate is not as easy as one might think. There are several factors that can impact the pricing of an interest rate.
First, let’s look at how interest rates are priced based on a lender’s rate sheet. A Par interest rate looks like this: 4% = 100.000. This means that the interest rate quoted neither costs money to obtain it nor does it give a credit back to the borrower. Credits can be used to pay closing costs.
Bank 123 may offer an interest rate of 4% with pricing at 100.000 for a $100,000 loan and an interest rate of 4.125% at 101.000. As a borrower with very little money in the bank, he/she would choose the 4.125% rate offered by Bank 123 because it offers a 1% credit back to the borrower. The borrower may choose the Par rate but would not receive a credit at closing. The difference in payment is about $7 more/less per month. A Loan Officer (LO) may not know the borrower’s financial shortcomings until well into the processing of the loan. Therefore, quoting an interest rate without this information would be a disservice to the borrower.
Bank 678 offers an interest rate of 3.75% with pricing at 99.750 (below Par) for a $100,000 loan and an interest rate of 4.000 at 100.000 Par. As a borrower with the ability to afford paying a little extra, the borrower would choose Bank 678 with the 3.75% interest rate and pay .25% in points (99.750 +.250 = 100.00 Par). Paying .25% in points for a $100,000 = $250. The benefit of paying $250 extra, breaks even only after 22 months. A LO may not know that the borrow is willing to pay extra to obtain a lower rate and the borrower not knowing that he/she has that option would also be a disservice to the borrower.
Let’s now look at other factors that affect interest rates. Base Pricing (bps) are fees charged by the lender based on programs requested or required from a borrower for loan approval. One hundred (100) bps equals 1 Discount point. One (1) discount point = 1% of the loan amount in fee. Why don’t we just say “a quarter discount point” instead of 250 basis points? Because some programs charge a fee of .008 basis points. Do you care to express that as a Discount Point?
Here’s an example of how basis points can affect the interest rate. Let’s say for example that I call Bank 678 and ask, “What’s the interest rate?” and the Loan Officer (LO) says, “4%”. Great! I give the information for the loan and the property address. I request that the rate be locked at 4% at Par (100.00) for 30 days. The LO starts digging into the file and finds out that I’m buying a non-warrantable condominium (see below). The cost for having a non-warrantable property is 500 bps. Next, I tell the LO that I’ve decided to pay my own property taxes and insurance (escrows - see below) and waiving escrows costs 250 bps. The LO tells me that if I want to keep the 4% interest rate, I will need to pay .5% for the condominium program and .25% for the escrow waiver, a total of .750% in points. I tell the LO that I don’t want to pay anything out of pocket. The LO will then look at the next higher interest rate to see what credit it offers.
4.000% = 100.000
4.125% = 100.500
4.250% = 100.750
The LO comes back to me and quotes me a rate of 4.25% which gives a credit of .750 which will cover the cost of the fees. I then tell the LO that I’ll let the bank pay the escrow and the LO then quotes me an interest rate of 4.125% which will cover the cost of the condominium fee. The LO ends up having to re-disclose documents to me due to the new government compliance regulations, which may then delay the closing for more than 30 days. Interest rate locks are quoted in increments of 7, 14, 21, 30, 45, 60 and some up to 90 and 180 days. The longer time frame the rate lock is set, the more discount points are charged. If the borrower can’t afford to pay the fees, the interest rate will need to be adjusted upwards to offer a credit to cover the cost of the fees.
Each program listed below may carry Base Pricing (bps) fees or Discount Point fees, which can increase or decrease the interest rate:
Loan size – Jumbo size loans, typically over $417,000, are not sold to normal markets. This is why jumbo products are called non-conforming loans (versus conforming loans). Fixed interest rates for jumbo loans are higher than fixed conforming loan amounts. Jumbo loans are almost always sold as an adjustable rate mortgage (ARM). Smaller loans, typically under $40,000, are sold to normal markets. However, the lower the loan amount, the higher the interest rate.
Type of property – The type of property affects Discount Points charged. Buying a condominium may require higher fees versus a single family home especially if it’s a high rise condominium or a condominium with less than 600 square feet.
Amortization of loan – The term of the loan will affect the interest rate. A 30 year loan and a 20-year loan typically offer the same interest rate. A 15-year or a 10-year loan offer a lower interest rate.
Loan Program – FHA interest rates are typically lower than conforming conventional interest rates. VA and USDA interest rates are also different. An adjustable rate mortgage (ARM) may also add points.
Usage of Property – If a person is buying or currently owns a rental property, Discount Points will be assessed. Primary residence use does not carry points, however a second home may have Points assessed.
Purpose of loan – Refinancing a loan for the sake of only lowering the interest rate will usually offer a better interest rate than refinancing a loan to pull cash out for home repair or paying off debt, especially if the Loan To Value (LTV) is over 70%. Depending on a lender’s needs, purchasing a home may offer better interest rates than refinancing a loan.
Credit score – A borrower’s credit score used to affect interest rates. Today, however, that practice is almost non-existent and a borrower should wait to increase his/her score rather than pay a higher interest rate. The only time you may see an increase in interest rate is if the buyer has a very low score (580 for FHA or 530 for VA) or a very high score (above 760) which may offer a better interest rate.
Loan niches – Sometimes a borrower may have to use niche products. Some example of niche products are Lender Paid Mortgage Insurance (LPMI) where the lender pays the mortgage insurance which requires points be paid, which may increase the interest rate; Down payment Assistance Programs (DPA) which may help the borrower with down payment or closing cost expenses. The interest rate is usually slightly higher than normal; Non-warrantable condominium means the condominium complex has not sold the minimum required amount of units in the complex required by Fannie Mae. Once the minimum is reached, Fannie Mae will then buy the loan from the bank if the bank wants to sell it to them; 100% Doctor/Intern loans usually require a higher interest rate as does a 24 months banking statements loan which allows a borrower to use bank statements instead of tax returns.
Loan To Value – Loan to Value (LTV) indicates the loan amount versus the value of the property. For example, if the property is worth $100,000 and the loan amount is $50,000, then the LTV is 50%. Interest rates are the same for LTV’s at 75% to 95%. LTV’s that are higher than 95% may cost points or lower than 65% may offer credit points (credit points can be used to lower the interest rate).
Escrow Waiver – Every year someone has to pay the property taxes and insurance (Escrows). Unless you ask to pay for them yourself, the bank will collect the money from you, which is included as part of the mortgage payment, and pay the respective entities the money due each year. If you choose to pay the escrows, the bank will not have access to the money you would have sent each month, which does not allow them to invest it for future profit. The bank will then charge you points (usually no more than a half point) for not paying them the escrow money.
This information may be helpful the next time you plan on calling a lender to ask, “What is the interest rate?” Different lenders have different rules and they may or may not have interest rate changes on the information listed above. However, it’s good to know this information about your loan to save time and to give the Loan Officer much needed information for the sake of clarity.
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