To Pay or Not to Pay
Ever wonder how a bank or broker can offer no closing costs? It's not rocket science, and don’t be mistaken, it's not done out of the kindness of their hearts. Its all a matter of playing with the numbers. Each rate comes with a price; the lower the rate, the higher the price. If the consumer is not rate sensitive, then it is easy to offer the no-cost rate. The rate will be substantially higher but, its cost-free.
Here is an example:
A rate of 5% may be offered at a discount of 1%. While the rate at 6% is paying a rebate of 2%. “Discount” in the mortgage industry means that you will pay for the rate. In this example, the consumer will pay one point for the rate. If the consumer chose 6%, then the bank would cover up to 2% of the closing costs. (These are not today’s rates and are used as merely an example of the “spread” between rates and costs.) The two percent may be enough to cover all of the costs or a large amount of them, depending on the loan amount. When paying points or getting a rebate, keep in mind that points are the same as a percentage (i.e. one point of $100,000= $1,000 - or - 1% of $100,000).
Why do the loans exist? If a consumer is refinancing then the rule of thumb is to calculate the time that it would take to recoup those costs in monthly savings. In a new purchase situation, perhaps a loan was written to take into account that the seller is contributing toward closing costs. If things change in re-negotiations (perhaps a low appraisal value) the seller may not be able to pay those costs. It may be an opportunity to take on a higher rate so that the buyer will not have to come-in with more cash than the required down payment.
When considering the difference between paying the costs and getting a lower rate, do the math. How long would it take to recoup costs. Experienced mortgage consultants should be able to find the ‘happy medium’ so that both, the monthly payment and the closing costs are affordable. Call your licensed loan originator to determine which plan is best for you.