Getting a better rate isn't just about comparison shopping. It's about understanding the levers to optimize your mortgage
Why rates vary?
Mortgage shopping for better rates isn't fun. Getting 3 quotes instead of 1 increases your likelihood of getting a better rate by 60%. Mortgage rates for the same borrower can vary between 0.5-1% across lenders. That's called rate dispersion. Why does rate dispersion occur? It's a mix of factors like CPI, MBS, and QT. Those acronyms aren't relevant per se, but it's important to understand that different lenders may offer different rates, just like some banks give you 0.1% for your savings deposits while others offer 1.0%. It's still bad overall, but you're better off with some shopping. There are new mortgage startups like OwnUp that help homeowners comparison shop across ~50 lenders based on interest rates, lender credits, and loan costs. In short, they help reduce rate dispersion with a quasi-concierge service. The other DIY option is an online mortgage marketplace like Simplist. It has more (~50,000) options but that overkill. Rates don't get much better after you shop around a little. Imagine you had no idea how much a jelly bean weighed. You don't have to weigh a 100, just three to be 99% sure what the weight is. It's nice to talk to someone too, when you're making the largest purchase of your life.
The key to getting a great mortgage isn't just rate shopping. It's understanding the levers available to reduce upfront down payments, overall interest rates, and closing costs. Loan costs in section A of the Loan Estimate are the key section to pay attention to. Other sections include services you can shop for (title insurance), and those you cannot (credit report, appraisal fee, recording fee etc.)
The key cost bucket to understand is Origination fees in section A. These include an underwriting fee, discount points, and origination points. Everyone's instinct is to look for the lowest charges possible on origination. Lenders & mortgage brokers know that and "move" their fees elsewhere. Understanding the difference between discount points & origination points could save you thousands of dollars, while getting a mortgage, and tens of thousands over the lifetime of your loan. Let's break it down.
About Origination Points
- Origination Points are a form of compensation paid to the broker/loan officer helping you originate your loan. If you're paying 6% to realtors, 1% to the person helping finance your home seems fair. It's a "cost" to "you" the borrower in exchange for the quality service.
- Origination points "most often" do not appear as a separate line item in your loan estimate. In such cases, the person helping you is getting "lender paid compensation." Your loan costs look lower, but your mortgage rate is higher. Lenders still make the same money on the loan and build in originator compensation into the rate. You may not notice the 0.25-0.5% increase in your rate because this is a widespread practice. However, a rate that's 0.25% higher ends up costing you $20,000 or more over the life of the loan.
- Transparency of origination fees incentivizes better quality of service. Lender-paid compensation is a bad deal for borrowers in more ways than one.
- Origination points can vary greatly across brokers and loan originators. If origination points are not transparently displayed, there's a higher likelihood of variance. The absence of evidence is not evidence of absent costs.
- Origination points can be conflated with bona fide discount points (which are very helpful to the borrower. 0.25 points shown here for a cost of $405 are bona fide
- Bona fide" discount points exchange cash paid upfront to the lender (not the loan officer helping you) that "guarantees" a drop in your mortgage rate, permanently.
- The cost of a discount point is always the same i.e., 1% of the loan amount, but the benefit can vary. A single discount point can drops rates by 0.25%-0.5%. The unit economics of 1pt for a 0.5% drop is fabulous. It's a 10x investment with a breakeven of <2yrs and a 10yr CAGR of ~20%.
- However, the unit economics of discount points are not linear - that means you could pay $2000 (or 0.5pts on a $400k loan) and reduce your rate by 0.25%, but the next $2000 (also 0.5pts) may only reduce your rate by 0.125%. In total, you could buy the rate down by 0.375% (0.25 + .125) for $4k, or choose to stop at $2k for a 0.25% lower rate. Both are good options. The number of discount pts to purchase depends on the cash available, length of stay, and if you think rates will move down.
Optimizing your mortgage
- Comparison shop, ask for the "par rate," i.e., no fees built-in., and ask about borrower paid compensation.
- Pay for origination points fairly to compensate the professional helping you secure funding. Understand that you're paying for the quality of assistance.
- Once you find a good par rate, re-quote the "rates" with 0.5->2 pts.4. 2 pts or $8k more may sound like a lot, but you could also reduce your downpayment by 5-10% simultaneously to save cash (vs. 20% down)
You could end up with a deal that has a lower rate, lower down payment, and builds equity faster! That's a great deal in our opinion.
