Mortgage quotes come with options that you may not be aware exist, but definitely need to understand if you want the best mortgage for your unique situation.
The terminology used by mortgage lenders to describe these options is probably foreign to most borrowers – par, above par and below par pricing.
These mortgage terms also come with more consumer friendly names – especially above par pricing and below par pricing. Consider par pricing in golfing terms – if you make a par you are even. You neither pay more or less for the mortgage rate quoted.
When your mortgage rate is above par it means the mortgage rate quoted is yielding additional funds to the lender. In the past that money typically went into a loan officer’s pocket, but those days are long gone.
Mortgage loan originators are paid a flat fee on every loan they originate. It does not and cannot vary based on the mortgage rate charged.
So, how does this above par and below par pricing work and how should you pick and choose when to use it?
Ins and Outs of Above Par (Lender Credit) and Below Par (Discount Points) Pricing
Discount points and lender credits give you options. They represent a tradeoff of out-of-pocket expense at closing or paying more/less on your monthly mortgage payment.
- Discount points (below par), lower your interest rate in exchange for an upfront fee.
- Lender credits (above par) lower your closing costs in exchange for a higher interest rate.
By law, points listed on your Loan Estimate and on your Closing Disclosure must be connected to a discounted interest rate.
The exact amount that your interest rate is reduced depends on the specific lender, the type of mortgage loan and the current state of mortgage market rate pricing.
Sometimes you may get a big reduction in your mortgage rate for each point paid. Other times, the reduction is smaller.
Lender credits (above par pricing) are simply discount points in reverse. You pay a higher interest rate – usually – and the lender gives you money to offset your closing costs. Pay less at the closing table, but more each month. Simple right?
By law, above par pricing must be passed back to the borrower in the form of a lender credit. It also must be clearly disclosed on the loan estimate and closing disclosure forms that every borrower receives – usually multiple times from application to closing.
The same goes for discount points, they must be applied to obtain your mortgage rate and fully disclosed.
Ever heard the talking heads on the radio blabbing about a “no closing cost” refinance? That doesn’t exist, it always cost money to close a mortgage loan – purchase or refinance. Someone is absorbing those costs and it is typically the lender in the form of above par pricing – a lender credit – originating from a higher mortgage rate.
Regardless, it is important to remember what we mentioned earlier – that mortgage rate and discount points – or lender credits – do not affect loan officer compensation. Nobody is pulling the wool over your eyes, it all has to be clearly disclosed at application, when you lock your mortgage rate and prior to closing too.
To Pay or Not to Pay
Whether or not you should pay points or agree to a higher interest rate in exchange for a lender credit depends in part on how long you plan to keep the loan typically.
If you are purchasing a home and a little tight on assets the lender credit can help alleviate that pressure and free up funds to move, buy furniture, etc…
This is referred to as the “break-even” point and you should always calculate it before you agree to pay discount points (below par) on your mortgage. The calculation is simple:
Discount Points Paid / Monthly Savings = Break-Even point.
For example, if you will pay $3000 for discount points and it yields a $50 per month savings your breakeven point is 5 years. If you have a 3-4 year plan to upgrade your digs then it doesn’t make sense to pay those points.
If you are planning on living in that house until you are pushing up daisies then you should strongly consider it.
Generally, if you plan to stay in the home (and with the mortgage) for a long period of time, it’s okay to pay for your closing costs out-of-pocket and even pay for a lower rate via discount points. You could save a ton in interest long-term by going with a lower rate.
But if you plan to move or refinance in a relatively short period of time or are short on assets when you purchase, a loan with a lender credit is usually the best deal.