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Should I Pay More Points For A Lower Mortgage Rate?

The answer most often given no doubt looks at current mortgage rates and while interest is a big part of the answer, it’s not the only cost paid by borrowers.

There is also an origination fee and, often, also one or more points.

The origination fee is a charge to compensate the lender for his or her work, typically an amount equal to 1 percent of the loan.

A full point is equal to 1 percent of the loan. In rough terms, if you pay 1 point at closing the cost of a 30-year mortgage will increase by 3/8ths of a percent over the life of a loan.

For instance, if you borrow $250,000 at 5 percent and pay 1 point at closing, the real interest cost for the loan over 30 years is roughly 5.36 percent. Note that 1 percent at closing is equal to $2,500 in this example.


The confusion comes when the lender says, “well, would you like to refinance at 5.36 percent and 0 points or 5 percent and 1 point? Or, we can finance your closing costs if you will pay 5.5% percent so you will have a no-cost refinance?

Huh?

To start, a loan with 0 points is called par pricing. It’s smart to always ask for loan quotes with zero points because that gives you a way to compare rates.

With the lender’s offer, here are some, er, points to consider.

  1. Points are paid in cash at closing. Generally they can be financed in the form of a higher loan amount.
  2. Interest rates with points are calculated over 30 years in the case of a 30-year mortgage, 15 years with 15-year loans, etc. The catch is that you might not live in a property for 30 years. In fact, the odds are overwhelming that you will sell or refinance long before 30 years (just think how often people move).
  3. If you sell or refinance before the loan term is up then your effective interest rate will increase. Why? Because you paid a set amount up front — say $2,500 for a $250,000 mortgage with 1 point — but the loan didn’t last 30 years. Once the money is paid it’s gone — there are no refunds.
  4. In reality, there’s no such thing as a “no cost” mortgage. Like a unicorn, it’s a rumor. Borrowers always pay. With so-called no cost financing the lender pays some or all closing expenses in return for a a higher rate. Given your credit standing and the premium interest rate, the lender can sell the note on the secondary market for additional money, thus getting back the closing costs plus (hopefully) a profit.
  5. If you’re refinancing it can pay to get a no-cost mortgage as long as your new monthly cost for principal and interest is lower than then current cost.

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act lenders can no longer charge a yield-spread premium or YSP by up-selling a loan with a higher rate or more points.

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Posted in: Mortgages

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