J
Janet_IHB
Guest
<strong>What’s the point?</strong>
<strong> </strong>
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. <strong>They should not expect any more from you, and you should not agree to any more.</strong> (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 <strong>without your knowledge and agreement</strong>. 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!
<strong> </strong>
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. <strong>They should not expect any more from you, and you should not agree to any more.</strong> (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 <strong>without your knowledge and agreement</strong>. 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!
