Points vs. No Points?

This piece is equally beneficial for both borrowers and mortgage originators! Borrowers are CONSTANTLY calling lenders and insisting on "No Point Loans". Lenders are often telling borrowers that they should shell-out thousands of extra dollars when "No Point Loans" are available. In this piece, I will not address third-party fees, but rather origination and discount fees , or points, as they are commonly known. Over the history of lending, banks, S&L's, Consumer Lending Companies, and knuckle-dragging "neighborhood" lenders have charged a fee in addition to the interest that they collect. The fee can be called many things: "juice", "spiff", origination fee, discount fees, extortion, etc. (Mortgage Professionals: keep reading. My jokes will be less aimed at the lending industry). The common term now used by both borrowers and lenders is "points". In this piece, I will address exactly what points are and whether or not they make sense.

Basically, points are an upfront, one-time, fee by the lender for the privilege of borrowing their money. Points are separate from interest rate charges that are being charged on the loan. Yes, points are figured into the Annual Percentage Rate (APR) of the loan, but APR and Note Rate are different and will be addressed, for simplicity's sake, in in another piece. Just remember, APR is a calculated rate including the costs of the loan and the note rate is the interest rate that your note has typed on it and is used to calculate your monthly payment. The note rate is what you brag about to your neighbors: "I got a 5.00%, 30 year, fixed rate mortgage". Generally, borrowers do not understand APR and they don't brag about paying points: "Woohoo! I paid three points!" It is natural for borrowers to not want to pay extra points if they neither understand how they work and nor how points can benefit them.

A point is equal to a certain percentage of the loan amount. One point is equal to one percent of the loan amount. Two points are equal to two percent of the loan amount. Three points are equal to three percent of the loan amount. Okay, you probably get how point(s) are figured by now. The figuring of points is easy. Whether or not it makes sense for a borrower to pay points is the hard part. Why is it hard? The borrowers out there think that points equal unnecessary cost and that the lender or broker is simply gouging them for extra fees. Obviously, abuse has occurred in the past and will likely continue to happen in the future. The borrowers, however, who have insisted on paying "zero point" loans are often likely to have screwed themselves in pursuit of bragging rights. Combined with many other factors, the paying of points may be the best, or worst, decision a borrower can make when securing a mortgage.

A poorly communicated fact is that points are generally charged so that the loan officer can keep the interest rate down. Remember, the loan officer needs to make money too. The loan officer gets paid one of three ways: by the borrower (called points, origination fees, and/or discount fees), by the lender (called rebate, "yield spread premium", or "Service Release Premium"), or by a combination of the the two (origination + rebate). The loan officer gets paid either way and a dollar is a dollar regardless of who pays it. Thus, the loan officer should be totally objective in his advice. Most loan officers will try to earn between one and two points on a loan (depending on the loan size) and they are required to disclose where they will earn said points. Thus, if a lender says he wants to earn 1.5% on a loan, then he can earn it from the borrower, the lender, or both. The questions that should be asked by both the loan officer and the clients will determine who should pay what and at what costs.

The first question that should be asked is "How long do you plan on keeping the mortgage?" This is the no-brainer question that many fail to ask. The longer a borrower keeps the mortgage, the more sense it makes for the borrower to want a lower interest rate. Remember, the more the borrower pays in points, the lower the interest rate; the lower the interest rate, the lower the payment; the lower the payment, the higher the savings over time. A simple example: If points on a loan equalled $5000 and saved a borrower $200.00 versus the "no point" loan, the client will recoup the costs in 25 months and will start saving $200/month, thereafter. For the engineers out there: yes, there are opportunity costs for the $5,000.00, and yes, you may be paying interest on the money, etc. But, points may be deductable and your investments could go south. I am sticking to simple examples in order that the main message comes across: paying points can work in the borrowers favor.

Paying points would not work in the borrowers favor if, in the example above, the borrower planned on moving out or if rates dropped significantly in the first couple of years. Another question is whether or not the borrower has the monies/equity available to pay points. Lets suppose that the borrower is purchasing a new home and does not have the extra $5,000.00 to bring in for closing. In this case, the loan officer is forced to raise the rate and let the lender pay him rebate. The borrower may have to pay the additional $200.00/month, but saves the upfront fees. Sometimes necessity trumps the optimal.

The interest-rate markets also have some bearing on whether a borrower should pay points. If a borrower believes that rates will come down in the future and that they can refi to a lower rate, without points, at that time, then God be with them. If they are right then they saved money. If they are wrong, then they will pay a lot more over the long run (assuming they are in it for the long run). Remember, borrowing is also a gamble.

I have found that most of the borrowers who paid points in 2001 and 2002 lost the bet as interest rates dropped precipitously on 2003 and they had to refi again to lower their rate. For those who paid points in 2003/4 (those who bought 4.875 to 5.0%, 30 year fixed vs. those who took 5.375% with no points) , they won the bet, will never have to refi again, and they will save a fortune over the long run. Given the current markets, it may make sense to do what most people do: pay a little in points and let the lender pay a little in rebate. It is a bit of a hedge for both sides of the argument.

The main point of this whole thing is that both the loan officers and the borrowers should consider many things before jumping into a loan that either charges points or does not charge points. Ask the right questions: "How long will you keep the loan", "Can you afford to pay the points", "Do you need a certain payment that is attainable by paying points?(ie: fixed income borrowers), "What are your feelings about the interest rate trends", etc, etc., etc., etc. Then do the math. The math does not lie.


MortgageMaster