Most buyers understandably want the lowest rate possible when they lock in their rate.
This is particularly the case when they believe rates are at an all-time low and when buyers believe they will keep their loan for 30 years.
But, as I remind readers often, very few people keep their mortgages for more than a few years because rates either drop again or because life events (tuition, marriage, divorce, job loss, babies, health issues, relocation, etc.) require a new mortgage.
Because so few borrowers keep their mortgages for more than 4 to 7 years (the range of “averages” from various surveys), we think buyers should consider asking for closing cost credits more often – particularly in certain rate environments.
CLOSING COST CREDITS ALWAYS COME WITH HIGHER RATES
As I reminded readers on Monday, lender credits for closing costs always come with higher interest rates; lenders have to charge higher rates in order to earn additional yield premium, to cover the credit, when they sell the loans.
WHEN TO REQUEST A CLOSING COST CREDIT
- Cash Is Tight. If cash is especially tight because buyers could barely scrape up their down payment, we almost always recommend closing cost credits.
- More Bang For Buck In Certain Interest Rate Environments. Currently, a buyer can get a credit equal to almost 1% of her loan amount if she increases her rate by only 1/4%. This is phenomenal because it often takes a rate bump of as much as 1/2% to generate enough extra yield premium to cover a 1% credit. Hence, NOW is a great time to request a closing cost credit.
- Short Time Horizon. Often when a buyer has a short time horizon for her loan, because she intends to relocate again, refinance or pay her loan down significantly, a closing cost credit is a great way to simply save money.
EXAMPLE: $500,000 Loan; Effect on Payment
My rate quote for today’s blog has a “no points” rate of 2.625%. $500,000 at 2.625% yields a P&I payment of $1,607.
But, if that borrower took a slightly higher rate today at 2.875%, she could get a lender credit for closing costs of almost $5,000.
At 2.875%, her payment would increase to $1,660, or $53 more than where her payment would be with a 2.625% rate.
But, it will take years of the higher payment before it exceeds the benefit she gets from the closing costs credit (it will take 95 months for the higher payment to exceed $5,000).
WHEN NOT TO REQUEST A LENDER CREDIT
- If the conditions above do not hold true, e.g. time horizon is long, cash reserves are ample and/or there is too little bang for the buck, meaning the rate increase in exchange for the credit is too large.
- If time horizon is TOO SHORT – No “Early Pay Offs” (EPOs) Please 😊. If a buyer intends to refinance or pay off her loan within six months of her purchase, the lender will have to pay a massive EPO penalty that will include all commissions, fees and closing cost credits.
Lender Horror Story: A few years ago, we had a buyer request an $18,000 credit for costs. We of course made sure that he had no intention of refinancing after close, and he gave us all assurances but we were played. Immediately after he closed, he informed us that a big bank contacted him to cajole him into refinancing. We were concerned, to say the least, because our total “early pay off penalty” would have exceeded $30,000, dwarfing the meager amount of money we made on that particular jumbo loan. We ended up having to pay our borrower a substantial sum simply to not refinance until the 180 day EPO period had run (at which time he was still able to get an even lower rate than the big bank offered initially).
Jay Voorhees
Founder/Broker | JVM Lending
(855) 855-4491 | DRE# 1197176, NMLS# 310167
