Mortgage loan fees: How do they affect your rate?
Mortgage loan fees are one of the great mysteries of real estate lending. What are these costs – and are they a bigger financial worry than mortgage rates?
If interest is the cost to rent money over time, then what are mortgage loan fees? It might seem as though there’s a simple list of typical fees – and there is – but if that’s the case, why don’t all borrowers pay the same costs? Checking the fees is part of mortgage shopping.See today's mortgage rates and fees from different lenders (Dec 12th, 2019)
This is a charge for processing your loan application. The application fee may be refunded when you close, or it may be part of the total loan charge. It costs lenders money to start a loan, whether you close on it or not. So some charge an application fee to cover at least some of their costs if you switch lenders after applying. You won’t get it back if you change lenders.
For this reason, it’s good to shop rates and compare costs before committing to a lender and applying for a mortgage. If you don’t like the idea of a non-refundable application fee, choose a lender that doesn’t charge one.
A mortgage application can involve hundreds of pages of documentation, much of which can now be obtained electronically by the lender with your approval. This material must be analyzed and verified for the loan to be approved. The underwriting fee represents the lender’s cost to process the mortgage.
This fee is often wrapped into a single origination charge. You may not see a separate line item for it.
When you lock in your interest rate for the standard 30-day period, it usually doesn’t cost anything. You can get a discount in your loan fee or interest rate if you lock for seven or 15 days. The shorter lock won’t help you, though, if you can’t close before it expires.
For those who want to lock for longer periods, there is often an upfront charge. That’s because the lender has to pay to tie up the money for an extended time, and can lose if you don’t close. So your upfront lock-in fee is another non-refundable charge if you take your business elsewhere after applying and locking.
A point is simply 1 percent of the loan amount. Origination fees are often expressed in points. The standard is one point, but you may find loans with a .5 point origination or other amounts.
Then, there are discount points. Paying discount points gets you a lower interest rate. For this reason, mortgage insiders call paying points for a lower mortgage rate “buying the rate down.”
Discount points are negotiable, and may or may not be a good deal. A point, is money spent at closing. Once spent, the money is gone. There is no refund. Does it make sense to pay points? That depends on how long it will take to recoup the cost.
Break-even: points versus mortgage rate
Typically, a point should get you a .125 percent to .250 percent rate reduction for a 30-year loan. If you take a $200,000 mortgage, here’s how it might look:
- The principal and interest for a 4.5 percent loan at zero cost is $1,1113
- If you pay one point and get a reduction to 4.375 percent, your payment is about $999, and it will take just over 11 years to recoup the $2,000 discount point
- But if you get a .25 reduction for that discount point, your rate drops to 4.25 percent, your payment becomes $984 and the break-even period falls to just over 5 years
So the decision to pay points or not depends on how long you plan to keep the mortgage, and if there are better things you can do with your money, like paying off a high-interest credit card or make a high-paying investment.
It’s nearly impossible to get a mortgage without some form of appraisal. The cost of a “full appraisal,” in which an appraiser personally travels to the property, inspects it inside and out, and then compares it to recent sales in the neighborhood, has gone up significantly in recent years. Expect to pay hundreds (or more for luxury properties).
Fortunately, many loans do not require the full treatment. Fannie Mae, for instance, offers an “appraisal waiver” for low-risk transactions. But its guidelines say that most borrowers won’t get waivers. If one lender offers it and another doesn’t, that’s a consideration when you finance.
Instead of appraisals, lenders can use “automated valuation models” or AVMs. An AVM program examines public records or real estate sales in your area and generates an estimated value
Shopping for a mortgage: fees versus rate
The general rule is that the lower your rate, the more you pay for it. So you’ll want to do a break-even analysis to see if it makes sense to pay more upfront or pay more each month. If you plan to keep your loan only a few years, or don’t know how long you’ll keep it, many experts recommend spending as little upfront as possible.
If you have a great interest rate, a long-term fixed loan, and have to plans to move in the next decade or so, it may be worth considering more expensive loans with lower interest rates. And if you need a certain rate and payment to even qualify, you may have to pay more upfront to secure it.
And by the way, it doesn’t really matter if the lender calls your fees an origination charge, a processing fee, or a hamburger. The bottom line total of the fees is what you should concentrate on. And if you want to make shopping easy, chose one interest rate and ask several lenders for estimates of your cost to get that rate. or decide what closing costs you want to pay and ask for the rate at that cost.
This makes comparing rates and costs easier. Alternatively, you can look at the loan’s APR, which helps compare loans with different costs and rates.
The APR (annual percentage rate)
The Loan Estimate form shows two interest rates: the stated rate, which the lender uses to calculate your mortgage payment, and the APR, or annual percentage rate. The APR incorporates the interest charges plus the costs of obtaining the loan. It then expresses this cost as an interest rate. The idea is that you can make a meaningful comparison more easily.
For example, here is how the same loan might look at three different price points:
- Stated rate: 4.5 percent, costs: zero, APR: 4.5 percent
- Stated rate: 4.25 percent, costs: 2 points, APR: 4.417 percent
- Stated rate: 4.00 percent, costs: 4 points, APR: 4,583 percent
In this case, the loan with the lowest rate has the highest APR. It will take a long time to recoup the cost of buying the rate down to 4 percent. The loan with the lowest APR is the second one, the one with 2 points. But is that the best deal? Not if it takes too many years for the monthly savings of a lower payment to cover the higher upfront costs of paying points. As a general rule, if two loans have a similar APR, choose the one with lower costs.
As always, speak with loan officers, run the numbers, and see which option is best for you.