Sun, Oct 21, 2018
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Thinking about using a lender credit for closing costs? You might want to think again.
If you are deciding whether to pay points or not there are a few things you need to know first. This is one area where homeowners make mistakes without realizing it.
What is a lender credit and why is it so important?
The answer to this question comes down to how your loan originator gets paid.
Will you pay the mortgage broker or will the lender pay them for their service?
This is important is because before the mortgage crisis loan originators were receiving commissions from both the borrower and lender. To make matters worse, they were getting the biggest commissions on the highest risk loans.
To put an end to these practices, the Federal Reserve Board set a rule that “prohibits a loan originator that receives compensation directly from the consumer from also receiving compensation from the lender or another party.”
Now when you take out a home loan from a mortgage broker they can only receive a commission from you or the lender - not both.
When you pay points on a home loan this covers the mortgage brokers fee for originating the loan. That’s how they make a profit.
On the other hand, if you choose a mortgage without points you will likely be paying a higher interest rate to cover these fees.
The interest rate you pay above the par rate (the current mortgage base rate) is called the Yield Spread Premium (YSP). For instance, if the current mortgage rate is 4% but your lender is offering you a rate of 4.25% then the Yield Spread Premium is .25%.
Now where does a lender credit fit into all of this?
Here’s where the new Federal Reserve rules come into play. If your lender charges an origination fee - such as a processing fee, underwriting fee, administration fee or application fee - the Yield Spread Premium must be given to the borrower as a credit.
Using a lender credit towards closing costs is popular because many homeowners are cash strapped. After all, they put all of their savings into a 20 percent down payment, will need to pay moving costs and still save up for potential home repairs.
Asking them to pay another $8,000 in origination fees and closing costs is probably out of the question.
In exchange for not receiving an upfront commission, mortgage brokers will offer an interest rate above the par rate to cover their costs.
As I mentioned above, the brokers cannot charge an origination fee and take a Yield Spread Premium at the same time. However, they can raise the interest rate to cover their costs so homeowners don’t have to pay any out of pocket expenses.
Although you avoid paying any upfront fees or closing costs by taking a lender credit, it’s important to note that your mortgage payment will be higher each month. You will also be paying more in interest charges over the life of the loan.
If you plan to move again soon, a lender credit will help you save money in the short-run. However, if your next home purchase is hopefully your last, you might save more money by paying the closing costs out-of-pocket in exchange for a lower interest rate.