Lending And The Real Truth About Rates And Costs

At times like the present when rates are near historic lows, a mania typically sets in about getting the very lowest rate available. However, it is important to consider the relationship between rates, fees and points.

If one takes the emotion out of the decision and analyzes things from a mathematical standpoint, it is often the case - especially in this market - that the lowest rate is not always the best investment.

Ultimately the decision is yours, but our goal is to help the consumer really look at things from all angles so that the program one chooses is done for all the right reasons and has withstood the scrutiny of reason rather than just being a product of the emotional frenzy.

Rates, rate sheets and rebates (which allow no point and no cost loans) are in constant flux. In the present market, yes, there are super low rates available, but the "sweet spot" is often at a slightly higher rate because the rebates fatten up considerably.

For example, I recently priced a $400,000 loan where there were no points at one rate, but for only .125% higher, the rebate was dramatically larger and allowed me to pay all the closing costs as well!

Of course, initially everyone wants the lower rate, especially if it's below some emotional threshold, but on the transaction above, the lower rate is in no way the better deal.

Closing costs on the no point loan would still be about $3,000 and the monthly savings of the lower rate only about $30. Waiting over 8 years to get a $30 monthly return on investment (ROI), no matter how long one thinks they'll have the loan, is not sound investing.

The way to help conceptualize this pricing is that, yes, the whole rate structure has moved down. However, it didn't move down uniformly, but rather hit a certain rate threshold area and flattened out wider which created much more rebate at slightly higher levels.

Hypothetically speaking maybe a one point loan moved from, say, 5.0 to 4.5%, but a No Cost loan moved from, say, 6.0 to 5.0. It wasn't that low rates weren't previously available, it's just that the change in the whole rate structure needs to be accounted for.

People will hear in this market about the person who got the really low rate - they're especially loud at the water cooler and cocktail party - but will rarely hear the story about the points and fees to get there.

The media is also dreadful at neglecting this relationship. For example when newspapers blurt out about the latest Freddie Mac loan being at X.xx%, it usually takes some further reading to find out that said rate included 0.7 points to get there. And closing costs!

As with the above example, it's often the case that the higher savings that accompanies the lower rate comes at too steep a cost when compared to the alternative.

Moreover, there is another very critical point that should be considered in all of this: there is a legitimate possibility that we are headed for a double dip in the economy and rates may go even lower. (Update note: or European Recession, Portuguese, Spanish, Etc... debt crisis, real problems in the Middle East, etc...)

If one has just paid costs for a loan, there will be some ROI period, no matter what. If rates go lower before the end of that period and a refinance makes sense, that money is out the window. Also, if rates go lower, it's harder to make the low rate really work if you've already paid to go low a few months or even a few years previous.

Of course if you haven't spent a dime and we do truly get the lowest rates ever, at that point, it may make sense to pay fees and/or points. And, having invested nothing, you should be able to capitalize regardless.

In short, in today's market, a no-cost refinance at a higher rate may be the best bet. If rates never get lower and actually go high, you've still improved your situation and are saving already from day one - a loan with fees might never catch up. However, if they do get lower, having not spent any money, you'll be able to get that benefit from that scenario as well.

Please do note that all this may change tomorrow, that every situation is different and that we analyze and re-analyze every deal to make sure. Also, these are just the numbers: there are emotions and other factors that we can't possibly account for that affect one and one's family. Ultimately, a client may decide that the low rate with fees and/or points is for them. It is prudent to ensure that the decision is made from the most informed standpoint possible.

Maddox Rees
Vice President
First Capital Mortgage Services
Montecito, CA 93108
September 4, 2012