Orlando Mortgage Blog

Anyone considering a first mortgage refinance recently that was shopping for a rate buy-up (where you take a higher rate and some or all the closing costs are paid by the lender) has probably run into this. Investors who have become very afraid of getting paid off early on their mortgage back securities and not attaining the expected yield on that investment are driving the coupon a lender pays much higher as the rates increase above Par.

What does this mean? Let me step back a moment. Par is the rate level, if you could get it, where no one gets paid by the lender at that rate level to do the loan and no points are charged by the lender on the yield. A rate below Par "costs" discount points to obtain, they make up the yield loss up front. The lower the rate, the higher the points charged. When you take a rate "above" Par, points are paid by the lender into the transaction and may be used to cover the origination fee and other closing costs up to a maximum percent loan-to-value depending the transaction rules. The higher the rate taken by the borrower, the more that gets paid and so on.

The problem in recent months is that investors are afraid that they won't make the investment yield they require on mortgage backed securities if they believe rates may decline. A refinance boom may have borrowers paying off their old loan early and the investor loses return on the investment. Therefore the hedge or "coupon" cost has gone up on the higher rate levels that would allow the rate buy-up and subsequent closing cost payment to take place. So, where in recent times you might expect a 30 year fixed rate that was around .50%+/- higher than a normal quote in order to pay your closing costs with the extra yield premium paid. Even a full 1% increase in rate today will not fully cover them and your loan person still must get paid to do the loan. Lenders simply aren't making buy-ups attractive presently.

There is good news for the typical borrower that wants to do a standard refinance where they roll-in of the costs and fees into the new loan. Fixed rates are at levels not seen since the 1950's. Recovery time of your closing costs on a new refinance will depend on how far your rate goes down below your current rate and therefore the payment drop you receive. Your monthly payment savings divided into the new closing costs will tell you the time it takes to recover your new costs ($100 monthly savings divided into $3,000 costs would recover in 30 months). In the mean time, your payment is lower from the first new payment onward. In the example above you would need to stay in the new mortgage 2.5 years to recover your costs.

Bill Wilbanks

Orlando Mortgage Masters