Understanding Points in A Mortgage Transaction
My Yahoo!Finance column for July 22 looks at new research that finds consumers who shop for a mortgage pay attention to the wrong issues and make mistakes that result in thousands of dollars in extra costs.
One of those costs that can cause a great deal of confusion is something known as “points” or “discount points.” I ran out of room to explain them in the story, so here’s the skinny: Points are an amount borrowers pay to “buy down” the interest rate on the loan. They only make sense if you’re going to stay in a home for a fairly long period of time, typically a decade.
Here’s an example: A borrower is offered a $200,000, fixed-rate mortgage at 6 percent for 30 years. The monthly payment is about $1,200 and the total cost (principal plus interest) is $431,676 over the life of the loan. A point is a percentage point. By paying two points (2% of $200,000, or $4,000) at the closing, the borrower can reduce the interest rate to 5.75 percent.
Under that scenario, the monthly payment drops to $1,167, so the borrower saves $33 a month. Divide the cost — $4,000 — by $33. The buyers would have to be in the home 121 months, or about 10 years, to break even. (With the lower rate, the total cost of the loan drops to $420,127, saving $11,550 in interest — less $4,000 paid in points – if the homeowner stays put for the life of the loan.)
I paid points on my mortgage to lower the rate because we knew we would be in the home for a while (it’s seven years and counting). I wanted a lower fixed monthly payment because as a freelancer, my income can vary from year to year. (I call it “The Starbucks Mortgage.” If the columnist thing disappears and I have to work as a barista, I can still pay the mortgage.)
my dream crib
The other issue to keep in mind is that if you pay points, that gives your mortgage broker additional compensation, and so you’re entitled to a rock-bottom interest rate. You want to pay “par” for the loan with no yield spread premium(something I explain in the column).
The key is to ask for options, says Carolyn Warren, a veteran broker/lender who assails dishonest practices in her book “Homebuyers Beware: Who’s Ripping You Off Now?
“Ethical honest loan officers always give borrowers a choice,” she says. “You can see which one makes the most sense for you depending on how long going to keep the property. The problem is people don’t ask for any options, and the loan officer doesn’t offer options – instead he says, ‘it’s a 1 percent origination fee and 5 percent rate on the mortgage.’”
Also beware of a lender who suggests you pay points along with an array of other charges. ”I see loans where there is a 1 percent origination fee, one point, and a big yield spread premium besides, and the broker ends up making $10,000 on the loan,” says Warren. “It happens a lot; brokers are paid upfront and on the back end and make more than a physician – and with high school diploma. But there’s no reason that has to happen to anybody if he is savvy and shops in a smart way.”
What’s your mortgage experience? Nightmare or gateway to the American dream? Share your stories and tips by commenting here, or email me at laura at laurarowley dot com.
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