Mortgage lenders make money two main ways – from interest and fees – and there is a tradeoff between the two. The higher your mortgage rate, the lower the lender fees you should pay and the lower your rate, the higher the fees.
If you pay a high enough mortgage rate, instead of you paying fees, the lender pays you a rebate. In short, the lender gives you money that you can apply to other closing costs and fees.
For example, a lender may charge you a flat fee of $995 if you pay the current market mortgage rate (let's use 4.000% in this example) on a $100,000 loan. If you agree to pay a fee of $1,995, so an extra $1,000, you may lower your mortgage rate to 3.750%. The lower your mortgage rate, the lower your monthly payment and higher the loan amount you can afford.
Alternatively, instead of paying the $995 lender fee, you may pay a higher mortgage rate of 4.250%. In this scenario, your monthly payment is higher but your closing costs are lower because you do not pay the lender fee.
How a Mortgage Rebate Works
If you are willing to pay an even higher mortgage rate, instead of paying no lender fee, you get money back from the lender. In the example above, if you pay a 4.500% mortgage rate – so .500% above the market rate – you could receive a $1,000 rebate when your mortgage closes. While the figures and scenarios above are only examples, they help illustrate the relationship between your mortgage rate and lenders fees as well as how a mortgage rebate works.
Use ourMORTGAGE COMPARISON CALCULATORto compare mortgages with different rates and fees
When is a Mortgage Rebate a Good Idea?
Although paying a higher rate increases your monthly payment and interest expense, and may reduce the mortgage amount you qualify for, the rebate can be helpful if you have limited funds to pay for closing costs. You may not have a lot of money left over after paying your down payment and possibly setting aside funds for reserves.
Mortgage closing costs can run thousands of dollars and you can use the rebate to pay for non-lender expenses such as the appraisal report, title insurance, settlement agent charges and other miscellaneous fees. A lender rebate may be especially useful if unexpected closing costs arise over the course of the mortgage process.
Please note that the lender rebate usually goes to pay closing and other transaction costs as opposed to you receiving the proceeds directly. For most mortgage programs there is a limit on the cash you can personally receive at closing from a rebate.
Why a Mortgage Rebate May Cost You More in the Long Run
It is important to understand that paying a higher interest rate to receive a lender rebate increases your monthly mortgage payment for your entire loan. Paying a higher payment can cost you more as compared to the rebate you receive.
For example, if paying a higher rate increases your monthly payment by $20 for a 30 year mortgage, your total interest cost increases by $7,200 ($20 * 360 monthly payments = $7,200). In this case, unless you receive a rebate of $7,200, then paying the higher rate costs more in the long run.
Find the Best Mortgage Terms then Negotiate the Rebate
We should emphasize that the actual increase in mortgage rate you pay to receive a rebate depends on many factors including your loan amount and, most important, the initial mortgage terms offered by the lender. It is important to find the lender that offers the lowest combination of mortgage rate and fees to begin with and then you can negotiate the actual rate you pay to receive the rebate you want.
If you select a lender that charges a higher interest rate and fees, then you end up paying more regardless of if you change the terms to receive a rebate. In short, if you want to end up with the best mortgage terms, then start with the best terms.
The table below shows mortgage terms for leading lenders in your area. We recommend that you contact multiple lenders to determine the interest rate, lender fees and rebate that are right for you. Shopping lenders is also the best way to save money on your mortgage.
“What are (discount) points and lender credits and how do they work?” CFPB. Consumer Financial Protection Bureau, August 3 2017. Web.