What is a mortgage par rate?
Quick insights
- A mortgage par rate refers to a starting interest rate that may be offered without paying mortgage discount points or receiving lender credits.
- It can serve as a reference point for borrowers when evaluating different mortgage rate options.
- The par rate may vary by loan provider and can change based on market conditions and the borrower’s profile.
In the world of mortgages, many words and phrases may sound complicated. The concept of a “mortgage par rate” can be straightforward and helpful guiding point when you’re preparing to buy a home. What’s more, understanding this rate could help you decide whether to pay more upfront for a lower interest rate or accept a slightly higher rate with fewer closing costs.
Mortgage par rate: A concise definition
A mortgage par rate is the base interest rate a loan provider may offer without needing to pay discount points or receive lender credits. It’s sometimes considered a “neutral” rate, before any adjustments are made to increase or decrease closing costs. The rate can vary by mortgage lender and specific factors, such as market trends and the individual borrower’s profile.
Understanding the par rate may help borrowers evaluate whether to pay extra and lower their interest rate or accept credits for a slightly higher rate.
How a mortgage par rate works
The mortgage par rate is shaped by a wide variety of economic factors and borrower-specific elements. While it’s considered a “starting rate,” it can shift frequently depending on the Federal Reserve monetary policy, investor behavior for mortgage-backed securities in the secondary market and your individual financial profile. Although the Fed does not directly set mortgage rates, they can be influenced by changes to the federal funds rate. When the Fed raises rates, borrowing typically becomes more expensive across the board.
Another key factor in a lender setting the mortgage par rate is the secondary mortgage market. Loan providers often sell mortgages to investors as mortgage-backed securities (MBS). If investor demand for these securities is strong, loan providers may offer more competitive par rates. However, if demand drops or risk perception rises, par rates can increase to offset lender risk.
Borrower-specific factors also play a crucial role. Even though the par rate starts as a general benchmark, the rate offered to you may vary depending on your situation, credit profile, loan type and financial history.
Common underwriting factors include:
- Credit score: Higher credit scores may qualify for better pricing.
- Credit history: A longer, positive credit history may indicate lower risk for the lender.
- Income: Steady, sufficient income supports loan repayment ability.
- Debt-to-income (DTI) ratio: Mortgage lenders evaluate how much of your income goes toward existing debt, known as debt-to-income ratio.
- Employment status: Stable, verifiable employment is a major component in obtaining approval for a mortgage loan.
When mortgage providers determine what par rate to offer, they rely on underwriting guidelines that assess risk. These guidelines help determine whether a borrower qualifies for a loan and at what rate. Two borrowers applying on the same day may see different par rates due to their individual financial profiles, circumstances and risk levels.
For example, Borrower A has a high credit score, low DTI, and stable employment. They could be offered a lower par rate compared to Borrower B, who has average credit and higher monthly debt obligations.
Economic trends that may affect par rates
Par rates may fluctuate in response to broader economic data. For instance, high inflation could lead to increased mortgage rates as the Fed raises interest rates to slow down price growth. On the other hand, rising unemployment or weaker economic growth might prompt lower interest rates to stimulate borrowing and investment.
Mortgage par rate adjustments
The initial par rate is just a starting point. Borrowers typically choose to adjust their rate up or down based on their goals for upfront costs or long-term savings. This is where discount points and lender credits come into play.
Discount points
Mortgage discount points are optional fees a borrower can pay at closing to lower their interest rate. One point usually costs 1% of the loan amount and may reduce the rate by about 0.25%, though this can vary. Here is an example:
Let's say you’re taking out a $300,000 mortgage:
- Paying 1 point = $3,000 upfront.
- If this lowers your rate from 7% to 6.75%, you may save thousands over the life of the loan through lower monthly mortgage payments.
Lender credits
Lender credits work in the opposite direction. You accept a slightly higher interest rate in exchange for help to cover some of your closing costs. For instance, if your par rate is 6.75%, a loan provider might offer a 7% rate and give you a $2,000 credit toward closing fees. This lowers your upfront costs, but with the higher rate, increases the total interest you pay over time.
Differences between par rate and other mortgage rates
Par rates can sometimes be confused with other types of rates but affect the homebuying process in a specific way.
- Par rate vs. APR: The par rate reflects the base interest rate, while the annual percentage rate (APR) includes lender fees, mortgage discount points and other loan costs. APR gives a fuller picture of your loan’s total cost.
- Par rate vs. discounted rate: Some loan providers offer “below-par” or discounted rates if you pay points upfront. This could be an ideal option for borrowers planning to stay in their home long enough to benefit from the lower monthly payments.
- Above-par and below-par rates: A below-par rate involves paying discount points, while an above-par rate includes lender credits. The base par rate sits in between, with no adjustments either way.
Here’s a hypothetical to illustrate the difference:
Borrower A has excellent credit and decides to pay two points, bringing their interest rate from 7% down to 6.5%. Borrower B has average credit and decides to pay a slightly higher interest rate of 7.25% in exchange for a $2,500 lender credit to cover closing costs.
Both options can work depending on financial goals, whether saving on the monthly mortgage payment or minimizing upfront costs. It’s important to consider your financial aspirations, budget and unique situation.
How does the mortgage par rate impact monthly payments?
Your par rate directly affects your monthly mortgage payment. For example, if you took out a $300,000 loan (assuming the down payment is 20%):
- At 6.25%, the monthly payment is about $1,477.
- At 6.50%, the monthly payment increases to about $1,517.
- At 6.75%, it rises to roughly $1,557.
Even a small rate difference can lead to thousands saved, or spent, over time. Locking in your rate when conditions are favorable may help secure better terms. Understanding par rates can also help when negotiating or comparing various mortgage providers’ offers.
In summary
The par rate is the starting interest rate before points or credits are applied. Unlike APR, it doesn’t include fees. Knowing how it affects your payment and total loan cost can help you make more informed decisions. It’s often a good idea to compare lender offers carefully and speak with a Home Lending Advisor before locking in a rate.
