What’s the point?
 
 
Since we have several first-time (eventual) homebuyers amongst us, I’d like to offer a brief introduction to home loan pricing.
 
When you go to a broker or lender (“B/L”), the quote you are given will include two major items: rate and points.
 
A “point” equals 1% of the loan amount.
 
Points are how the B/L gets paid for their services. In this example, we often refer to them as “origination” points.
 
You may be asking yourself: why do I have to pay my B/L for the privilege of taking my business? Well, your loan involves work. It also involves risk. Your B/L takes on risk from the moment they pick up the phone to talk to you. Some B/L’s are actually financially responsible for losses associated with your loan. This is generally not enforced, unless fraud is involved, but it is there.
 
There is a second class of points as well, called “discount” points. Discount points are different. They are used by you to buy down your interest rate to below-market levels. (The market rate might be 6.5%, but you are demanding 6.25% - so you would pay extra point(s) to obtain your desired rate.)
 
For the remainder of the discussion, we will stay focused on origination points.
 
Let’s say you have picked out your $1,000,000 dream home at 50% off, or $500,000. Let’s also say you would like to put down $100,000 and finance $400,000.
 
Your B/L looks at your credit, income, employment and assets, and determines it can offer you a 30 year fixed loan for $400,000 at 6.25% and 1 point cost.
 
You are now saying to yourself (and anyone who will listen): I don’t want to pay points!
 
OK – we have another way.
 
Your B/L can take its fee over time, in the form of a slightly higher rate on your loan. (They actually get it right away, you just pay over time.)
 
You are still angry, but you accept that it’s just business – so you continue on to analyzing your options.
 
(I am just having fun here – please don’t be upset!)
 
Your B/L gives you two options to consider:
 
A)    A $400,000 30 year fixed loan at 6.25% and 1 point cost; and
 
 
B)    A $400,000 30 year fixed loan at 6.50% and no cost.
 
 
If we are speaking of a lender, you will not see how this happened – you will only know the end result. If we are speaking of a broker, you will see that the broker is getting his fee in the form of yield spread premium (YSP). That means the entity that actually funds your loan pays your broker for you, by giving him a “rebate” equal to the 1% in question.
 
So, now you have to do some math to make an informed decision.
 
(We will assume an interest-only loan here for the sake of simplicity.)
 
The interest payment on the loan at 6.5% is $2,166.66.
 
The interest payment on the loan at 6.25% is $2,083.33.
 
The difference between the two is $83.33.
 
The origination point we are trying to raise is 1% of $400,000, or $4,000.
 
If you elect to go the 6.5% / no-points route, you will break-even after 48 months ($4,000 / $83.33 = 48).
 
If, in this example, you were looking at a 3 year ARM, and not a 30 year fixed, you would likely not have the loan out the entire 48 months, and would come out ahead by taking the higher rate. This would also hold true with the 30 year fixed example, if you knew you would sell before the 48 months are up.
 
However, if you are smart, and are in the deal for the long haul, you would blow right through the 48 month break-even point, and your choice would come back to haunt you.
 
Remember that $83.33 difference?
 
If you kept that loan for 30 years (360 payments), you will have found that you paid a total of $29,998.80 in lieu of paying your B/L their $4,000.00. (It wouldn’t really be that severe if your loan payment included principal, because the balance would be declining.)
 
 
Helpful hint: Your B/L deserves to be paid for their services – just like your CPA, mechanic, shrink or anyone else!  If they are charging you one point, it is a perfectly reasonable fee. Even two points is not outrageous, depending on your loan. They should not expect any more from you, and you should not agree to any more. (There is one exception: let’s say your loan is for $50,000 and your B/L has a $1,500 minimum fee to offset their risk. In this example, they would need to charge you 3 points to meet the minimum.) Your B/L should not charge you upfront points, and then make extra YSP without your knowledge and agreement. Brokers will provide you with a Good Faith Estimate (GFE), which lays out all these items. You must look at the totality of what you are quoted.
 
I hope this helps!   
 
 
 
 
 
 
 
 
 
 
 
 
 
 

VERY helpful.  Thanks Janet!  Now I’ll know what they’re talking about when I look to buy after the bubble

Also, you can deduct your point(s)!   

"Your B/L deserves to be paid for their services – just like your CPA, mechanic, shrink or anyone else!  If they are charging you one point, it is a perfectly reasonable fee. Even two points is not outrageous"
Unless I am reading this INcorrectly, this comparision is just wrong, and make ZERO sense.   CPA, mechanic, shrink get paid ONE TIME for  A VERY SPECIFIC SERVICE by the customer. 
Commisionned brokers get paid by the source of the Money, and by the spread.  1% or 2% origination fee ( which doens’t reduce interest rate) might be reasonable if the broker pass along the commission, and the buy rate. IF the broker keep the half point commission, and keep the spread, and charge the origination, then they are double dipping - from the lender, and from the customer.  You can say that is the "practice" they can get away with when dealing sometimes,  just like realtor get paid 6% for a transaction, but say they "deserve", that makes no sense.
 

"Your B/L should not charge you upfront points, and then make extra YSP without your knowledge and agreement."
Please re-read.

To clarify:
The total front & back should be within the 1-2% range.  Preferably 1%.

Janet, thanks for the clarification! I guess I just read it too fast…I guess that this is an example of someone who didn’t study too hard in high school and didn’t get reading skills sharpened

First let me say that Janet explained that very well. Second I will explain how I used to price a loan.
I would know within the first five minutes if the borrower was going to be a PITA or and easy no hassle deal. I would collect anywhere between $2500 to $4000 in gross fees. That is any processing, origination or YSP in "fees". So instead of looking at as a percentage of say 1% origination or 1% YSP I had in my mind what I needed to make. Yes I made more than $4k on a loan but I also made a lot less than $2500. However my average was $3200 in gross fees. If you think this is high then I suggest you go to a bank directly and ask them if they can do the loan for a $3200 gross flat fee. If you can get a straight answer they can’t.
I wouldn’t look at it in percentages and there are several brokers who now work on a flat fee. I like this idea and yes brokers should get paid and they should give you the best product for that fee. It’s too bad that a bunch of azz hats like Quick Loan Funding and the like ruined it for the good brokers even though QLF shot themselves in the foot anyway.

What’s a PITA (please don’t tell me flat bread at Jack and the Box)?

pain in the azz

Thanks! 
One time at lunch, my friend’s mom - a snooty woman - after seeing the couple being sat at a table next to ours, leaned over and whispered to my friend and I, "they’re NOKD." 
"What’s NOKD we asked."
She replies, "Not our kind, dear!"
I just thought that was so funny for so many different reasons.  

I am reminded of another tip:
The same principle (time value of money (maybe present value is better?)) that makes it prudent to pay fees upfront, is applicable to debt-consolidation refinance loans.
Many people buy the line-of-thinking that, if they roll consumer debts into their home loan, it is better because the "payment" is lower. 
This is false.
Yes, consumer debt is typically at a higher rate than (deductible) mortgage debt.
However, consumer debt generally has a much, much shorter "maturity".
For simplicity, if the consumer debt is $4,000.00, like in our prior example, it will cost you much more (thousands and thousands more) to spread it out over 30 years.
You would do better to attack it one of the following ways:
1.  Pay it off as fast as possible; or
2.  Go ahead with the refi - but apply some extra cash to the mortgage in its early years, i.e., in the same amount of time the consumer debt would have been paid off.
Option 2 requires discipline!

Janet,

I am glad you pointed out the consumer debt consolidation problem. People don’t realize they are paying off that trip to the mall for the next 30 years when they do one of these refis.

Remember on another thread we were talking about other industries that will be harmed by the collapse of the real estate market? Credit card companies are also going to get hosed. Before people go under, they will tap every source of credit available to them. As each of these distressed homeowners goes under, they will take $100,000 worth of credit card debt with them to the bankruptcy judge.

Thanks - I agree.
Although they will have to make good on some of it.
Those "7" jeans don’t look so good at $3,000!
No amount of arse-shaping is worth that!

Nice post Janet, that is very helpful and something I will certainly look out for when buying a house.
Not to be nit-picky, but there is a time-value of money factor that will stretch the break-even on that deal to over 7 years in your example, based on a 5% return rate.  So if you plan on staying less than 7 years, rolling it into the loan might not be a bad idea!

Thanks Gepetoh.
Good point.
I thought of that, but didn’t want to overload anyone.
 
 

Janet,

Thanks for the tid-bit.  Since I have never been through the loan process it’s nice to now know what to look out for.

Janet,
    Nice post, I had to learn about this the hard way as well as when I went to buy in the commercial world, they had LOTS of ways of hiding all their fees.  I’m just suprised that some people charge a MINIMUM of 3 points… seesh, that can be quite a bit of change.
-bix

Janet  or lendingmaestro -
Do you know of a public website that will show the breakout of principle and interest for a monthly mortgage payment.  I realize you mostly pay interest for a few years, but I would like to see it detailed out for principle & interest.
Thanks!

CalGal-

Use the mortgage payment calculator on bankrate.com:

http://www.bankrate.com/brm/mortgage-calculator.asp

When you finish entering your figures, click the "Show/Recalculate Amortization Table" button.

Cool - thanks, jwbrown77 

Bix,
(If I understood you)
The 3 points wasn’t the minimum in the example, the dollar amount of $1,500 was.
There is no economy-of-scale in very small loans, so the dollar floor gets converted to a higher number of points than it would on a larger loan.
Many lenders won’t even fund a loan that small.
 
 

Graphrix makes a good point about (defacto) flat fees.
Many brokers already price loans in the exact same way as he describes.
(Which is to say, they just make sure they hit a number that makes it worth doing.)
Most brokers who work on referrals-only operate this way.
 

I know referral-only brokers who push through 4 points on every deal.  Depends on your clientele and the level of service you provide.  Yes even $20-30k to the broker may make sense for many borrowers.  If you deal with clientele that are likely to shop and/or you want more transparency from the start then a fixed fee may make more sense from the broker’s perspective.

Ouch!
I guess it’s not impossible that they could really earn it.
I’m also sure plenty of clients really may not care.
Your life is laid bare when you go through this process, and you may not want just anyone to know your business.
I can’t think of a more invasive experience (with the exception of a colonoscopy)!
 

Thanks for explaining how points work and affect your payments.
Can you explain to me how brokers/loan officers get paid - I mean, even with zero point (to the customer) loans, aren’t they still getting quite a bit of money?