Consider the scenario where you are offered a mortgage credit of $55,077 rather than having to pay a fee for a new loan. Specifically, for a $4.125 million, 10/6 ARM at a 3.625% rate, this is the quote I received. It seems logical to think that getting a large credit is more advantageous than paying a fee, but it’s not that simple.
When you agree to a higher mortgage rate, the mortgage credit you receive increases, as the lender benefits from a wider interest rate spread on your loan.
However, it may be more prudent to choose a lower rate of 3.375% with a $3,514 credit if you are a well-qualified borrower. With monthly savings of $576 on your mortgage, you’ll reach a break-even point in 89 months.
Here’s how that 89-month figure comes about: it’s the $51,563 difference in credit divided by $576. If you’re planning to hold the mortgage for more than seven-and-a-half years, you’ll gain an advantage, assuming all else remains the same. Investing the difference with positive returns will get you to the break-even point even quicker.
Many argue that choosing a lower mortgage rate with fewer credits may be the better choice. However, another perspective suggests that it might be wiser to pay a small mortgage fee instead of taking a large credit. This was something I hadn’t realized until recently.
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In Most Situations, Paying A Mortgage Fee Is Preferable To Receiving A Large Credit Why Paying a Mortgage Fee Instead of Accepting A Credit Might Be a Better Choice I found out from a Citimortgage officer that you may not actually receive the entire mortgage credit, especially if it more than covers all fees. As a consequence, it’s often preferable to opt for a mortgage rate that is as close to no-cost as possible.
Continue reading to learn why paying a mortgage fee might be a wiser decision than receiving a credit. I spoke to the Citimortgage officer to clarify his previous rate snapshot.
Excess Credit Remains With The Lender Me: The $55,077 credit seems appealing with a 3.625% mortgage rate. If the fees are $11,955, would I receive a $43,122 cash credit ($55,077 – $11,955)? Or would I get the full $55,077 credit after all fees? If not, where does the credit go? To a lower loan amount? Or as cash back in my account?
Mortgage officer: Theoretically, you could get that credit. However, there are restrictions, meaning the credit must cover actual closing costs. Any excess would stay with the lender. The best approach would be to choose a 3.375% note rate with a $3,500 credit, leaving around $14,000 in closing costs. For example, a 3.5% note rate with a $29,000 credit would pay all your closing costs, but you’d leave $11K with the bank since the actual costs are $18,000.
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Me: Understood. Could the leftover $11,000 credit from a 3.5% note with a $29,000 credit be used to reduce my mortgage by $11,000? If not, do I just lose that remaining $11,000 credit?
Mortgage officer: No, the credit wouldn’t go towards reducing the loan amount. If not applied to closing costs, it’s a total loss. Even though we talk about the credit in dollar terms, it’s more of an accounting measure. Higher rates are more “valuable,” but not in hard dollars. It offers the customer options.
I would recommend the 3.375% in this situation. Typically, the dollar difference between note rates isn’t this significant, but with a large dollar loan, minor rate differences result in huge variations in credit or points.
Remember, these figures are hypothetical, as the rates are old. When locking in rates, we might find a point where we could cover about 80% of the closing costs without leaving money on the table.
Paying A Small Fee Is Better Than Receiving A Large Credit Securing a new mortgage or refinancing has become challenging due to strict lending standards. However, if you can get a mortgage, then paying a small fee might be preferable to receiving a large credit.
Ideally, you’ll want to select a mortgage rate that offers just enough credit to cover 100% of the cost to initiate or refinance a mortgage. Any excess credit above the mortgage cost is wasted.
Even if you end up paying more in mortgage costs, you may still come out ahead if mortgage rates stay the same or increase and you keep your mortgage long enough.
Banks Will Always Profit From Your Loan Remember, there are no freebies when initiating a new mortgage or refinancing your existing one. The bank will find ways to profit, and the exact amount may not be disclosed.
A good lender will present you with various rate and fee options. It’s then up to you to decide what best fits your situation. Always ask for clarification if you’re unsure about anything.
In the past, I used to go for “no-fee” mortgages, receiving any overage credit by check or electronically, but the amounts were minor. Now, I would aim for a “low-fee” mortgage to minimize waste.
Thoughts On Real Estate Today Currently, I don’t advise taking on debt to purchase property. Instead, consider carefully investing in public REITs or private real estate funds without leverage.
Platforms like Fundrise offer opportunities to invest in single-family and multi-family rental properties. You can also explore individual real estate options in fast-growing cities with CrowdStreet.
If inflation shows signs of slowing, risks in stocks and real estate may decrease. Being well-positioned for a turnaround is wise, as real estate has been a proven wealth builder over the long term.
