EVALUATING INTEREST RATES

When considering the interest rate associated with your home loan, it is important to understand that once qualified for a particular home loan program, you will have a variety of interest rates available to choose from. This fact is something most people never realize, and is a costly mistake. The purpose of this article is to breakdown home loan interest rates for consumers to understand the differences between their interest rate and the price associated with their home loan. With this fundamental understanding you will be able to evaluate the interest rate and closing costs associated with a proposed home loan in conjunction with your personal plans for the sole purpose of determining the benefits of the proposed home loan.

Once qualified for a home loan you will have a wide variety of interest rates available to you. Usually this point remains undisclosed to the consumer; regardless this remains a truth in nearly all situations. Of all the interest rates offered to you, one will be deemed you “par” interest rate. “Par” is an industry term for the interest rate closest to coming at no cost and paying no yield spread. For this reason you can think of par as your neutral interest rate.

Every interest rate that is offered to you is going to have a charge associated with it, with the par rate separating the charge into two forms either postive or negative. If the charge is positive the interest rate comes at a cost, if however the charge is negative that interest rate is above market and is paying the originating agent yield spread or rebate out of closing. If the rate pays enough yield spread, a no cost home loan can be accomplished. Whether this is the best option is something that should be evaluated, and we have custom calculators available to clients not published on this webstie that to do just that.

Here we have an example of an internal rate sheet that is usually not shared with the public. Across the top you will see a variety of interest rates which change thoughout the day based on market fluctuatoin. These are all the interest rates available to you at this particular time. As the secondary market (which is where mortgage notes are sold by all the major lending institutions and where the interest rates are established) moves up or down these rates will move accordingly. Below the rates are pricing adjustments that are particular to this situation (your pricing adjustments may be better or worse). These pricing hits will remain static for all interest rates as long as the loan parameters do not change. The final category at the bottom labeled “FINAL Points/Rebate,” is a total of the price adjusters and the final cost or rebate of the interest rate listed for the home loan you are seeking. Notice that the lower the interest rates have the higher cost while the higher interest rates pay more yield spread to the originating agent. In this particular example your par rate falls between 5.000% and 5.125% because 5.000% comes at a slight cost (.25) and 5.125% pays a slight rebate (-.25).

So what does “FINAL Points/Rebate” mean to you in dollar figure? Multiply the Final Points/Rebate by your loan amount and you will know how much that rate will cost you, or how much that rate is making your loan officer in rebate. For example on a 200,000 dollar home loan 4.875% at a cost of 1.000% would mean 2,000 dollars up front which is the cost of the rate. Let us add another one point for the originating agents fee for service which is another 2,000 dollars for a total cost of 4,000 dollars, while 5.875% paying -2.000% in rebate would pay the originating agent 4,000 dollars. To continue, a home loan for 200,000 dollars with an interest rate of 4.875% has a monthly payment of 1,058.42, while the same loan amount at a rate of 5.875% has a payment of 1,183.08 (both payments amortized). The difference is 124.66 a month. Over a 30 year period or 360 payments you will spend 44,877.60 more by accepting the higher interest rate. The gross difference between the two is 8,000 dollars which can clearly be made up in savings over the course of the loan.

So how do you use this information to evaluate your personal situation? By understanding how your interest rate is determined and the costs associated with each particular rate you will be able to plan accordingly. If you know you will be selling your home in a short period of time, the no cost loan may make more sense, in our example above it will take about 65 months to make up the 8,000 dollar difference between rates; so if you will be leaving inside this timeframe it would not make sense to take the lower rate with higher costs. On the other hand if you plan on keeping you home loan for a long period of time the best course of action would be accepting the lower interest rate, at the higher cost because the monthly savings would make it worthwhile after 65 months or approximately five and a half years. Of course it may make sense accepting a rate somewhere in the middle of this spread and looking into a low cost loan. The point is these options are rarely explored to their full degree, and doing so is an exercise well worth the time because it allows you to fine tune the cost of closing to your particular situation.

Evaluating which interest rate has the most benefit for you is something your loan consultant should be willing to help you with. With that said it should be mentioned that this is not always the case, moreover certain lending institutions, namely those carrying a CFL license are not required to disclose yield spread/rebate that is collected at closing, therefore if you are not working with a lender that is entirely forthcoming, you may not be aware of some of these options. Moreover the lender could choose to simply keep the entire yield spread/rebate and charge an up-front fee for service costing you sgnificantly more than is required.

For this exclusive reason it is important that the lender you chooce to work with is willing to provide you a full disclosure of the fees you are being charged. Usually this means agreeing on a set fee for service that the loan officer will be making. Once this is determined, how the fee for service is made is irrelevant, and full disclosure of pricing associated with the rates can be discussed in full confidence. At the time you lock the rate for your home loan your lender should be able to demonstrate on the lock confirmation the yield spread or cost of the associated interest rate, and the remaining fees can be adjusted if necessary. The rate lock confirmation is something most consumers do not ask to see, but it is a very useful document to have and is recommended that you request one from your lender as soon as your loan is locked. It should not be a problem for your loan consultant to provide, and if it is that may be a sign of something amiss.

By taking action, you will play and active rather than a passive role in determining to cost of closing for your new home loan. This will help ensure that your future goals are met and the home loan is contributing to your overall plans rather than standing in as an obstacle. Because most people’s home loan is their largest form of debt, it is crucial the terms be in line with their future plans and this is one of the most effective forms of evaluation.

We are committed to servicing our clients, and hope you have found this information helpful. For more information, please feel free to contact us directly so we can assist you on a personal level.

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