In Friday’s Blog, I pointed out how many things affect a buyer’s interest rate, including Credit Score, Loan Amount, Property Type, Lock Period, LTV, etc.
But – I received questions asking how “points” and “origination fees” affect rates – the subject of today’s blog.
POINTS, ORIGINATION FEES, & DISCOUNT POINTS
Even though distinctions can be made, Points, Discount Points, and Origination Fees are effectively the same thing and they are used interchangeably.
A “point” typically represents 1% of the loan amount. So, 1/2 point is 1/2% of the loan amount, and so on.
Paying a full point will typically “buy down” an interest rate by about 1/4%, depending on market conditions.
Hence, it will take about 4 years to recoup that point.
But, that point is also tax deductible in the year of the purchase, so the recoup period can technically be shorter when tax benefits are taken into account.
Lender credits affect rates in much the same way that points do, but in the opposite direction.
Typically, if a lender increases the rate by 1/4%, it will be able to offer a closing cost credit of approximately 1% of the loan amount.
The exact amount of the credit again depends on market conditions.
Why we don’t recommend paying points
We typically don’t recommend paying points b/c we think buyers get too little bang for their buck; paying points depletes cash reserves; and buyers often end up refinancing long before they make up the points with their interest rate savings.
Why we do recommend lender credits
We encourage borrowers to take advantage of lender credits whenever cash is tight b/c they can always refinance into a lower rate after six months. The risk of course is that rates might increase and buyers will then be stuck with the higher rate.
Watch out for “Fake Points”
Some lenders portray points as something that is necessary to buy down a rate, when they are already making an ample “rebate” on the back end (obtained when they sell the loan).
I knew a loan officer who used to tell all of her clients that FHA required that she charge a point even though she always earned a 2% to 3% rebate on the back end.
I never played that game of course, and it is why I am still in business and she is not :).
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