Here are a few mortgage lending concepts that agents should understand:
I. Points, Discount Points, and Origination Fees
Although distinctions can be made, Points, Discount Points, and Origination Fees are effectively the same thing and are used interchangeably.
A “point” typically represents 1% of the loan amount. So, a 1/2 point is 1/2% of the loan amount, and so on. Paying a full point will typically “buy down” an interest rate by about 1/4%, depending on market conditions.
Hence, it will take about 4 years to recoup that point. We typically discourage paying points because borrowers often refinance before recouping the benefits – and it also depletes cash reserves.
Sometimes, though, we must charge points when an investor (often in the non-QM space) does pay “rebate,” “yield premiums” or “commissions,” meaning that the only way we can make money from the loan is by charging points because the investor to whom we’re sending the loan will not pay us. Borrowers also need to watch for “fake discount points” that don’t actually buy down the rate.
Here is a longer blog I wrote about this: Points, Discount Points, & Origination Fees
II. Rebate, Yield Premium, and Commissions
I referenced this above because it is so important and it is how most loan officers/lenders get paid. Most loan officers just use the term “rebate,” and it refers to the amount of money lenders get paid by the “investor” (explained below) that buys or funds their loan. The higher the rate, the more the loan officer/lender gets paid. An interest rate that pays no rebate/commission is called the “par rate.” If a lender locks a rate 1/4% above par, it will get typically get a rebate of about 1% of the loan amount. 1/2% above par will earn about 2% of the loan amount, and so on – but only up to a point (investors will not continue to pay at that ratio forever).
And again, if a lender cannot obtain a rebate, it will have to charge the borrower points to earn money for the loan.
III. Investors vs. Lenders
This is extremely confusing for most people outside the mortgage industry. The vast majority of all mortgage loans are funded by non-bank lenders known as “mortgage banks.” These mortgage banks never retain loans in a portfolio but instead sell every loan they fund on the secondary mortgage market to entities known as “investors.” These investors include large commercial banks, large firms that “aggregate” mortgage loans like Pennymac and Redwood Trust, Fannie Mae, Freddie Mac, private equity firms, mutual funds, and REITs. So, even though JVM is a “lender,” borrowers will often hear us say that the “investor needs this.” This is because we know which investor we will sell the loan to, and we comply with that investor’s guidelines upfront.
To make things more confusing, we sometimes “broker” loans to outside investors – when we do not have a particular loan program in-house. This means that we package the loans for underwriting, but we do not underwrite or fund them in-house. We instead send them to an outside lender/investor that underwrites and funds the loan themselves – and that sends us a commission (based on our rebate or the points we charge).
IV. Early Payoff (EPO) Penalties
Investors that buy loans subject mortgage banks and loan officers to “early payoff penalties.” If a mortgage bank sells a loan to the investor and the borrower pays off the loan in less than six months (the usual EPO period), the mortgage bank will have to pay a penalty equal to the rebate or “yield premium” that the investor paid to the mortgage bank. For example, if a mortgage bank sells a $500,000 at a rate that is 1/2% above “par,” that mortgage bank might get $510,000 for that loan. If that loan pays off in less than six months, that mortgage bank will owe a penalty of $10,000.
To be clear though: These EPO penalties are paid by the lenders only and NOT by borrowers. This is why lenders encourage borrowers to wait six months to refinance or pay down their loans. This is also why it is risky for lenders to try to charge too high of a rate (to get more rebate) because it makes the risk of a refinance and a large EPO penalty much higher.
Here is a longer blog about this: What Are Early Payoff Penalties?
