Points & Origination Fees - And Why We Discourage Them

A man walks to his house in the winter carrying groceries. He purchased his home using points and potentially wasted his money.

I recently blogged about 5 Misleading Rate Quote Tricks that everyone should be leery of and received some questions from our readers.

WHAT ARE POINTS?

Some readers asked about the $9,000 of “points” that another lender had tried to hide in the borrower’s new and larger loan.

I touched on this last year and am repeating much of what I wrote, as little has changed.

EVERYONE WHO PAID POINTS IN 2009 WASTED THEIR MONEY

In 2009, when rates fell below 5% we refinanced our entire database and many borrowers wanted to pay points to buy down their rate.

As a reminder – a “point” is 1% of the loan amount, and points and origination fees are often used interchangeably.

Our borrowers wanted to pay points b/c: (1) they thought rates had hit an all-time low and they wanted the lowest possible rate; and (2) a point could buy the rate down as much as 1/2 percent (much more than usual) at that time.

BUT – within a year rates had fallen significantly again and every one of those points-paying borrowers ended up refinancing again.

Hence, the points they paid were a total waste of money. Ever since that experience, we have been advising against paying points.

1 POINT BUYS RATE DOWN 1/4 PERCENT

As a quick aside, in today’s market, 1 point would buy someone’s rate down by about 1/4 percent.

This means it would take about 4 years of savings from the lower rate to offset the cost of the point.

The lender I reference in Friday’s blog was charging almost 2 points, requiring 8 years to offset that cost (far too long in our opinion).

WHY WE DON’T RECOMMEND POINTS/BUYING DOWN RATES

Too Little Bang for the Buck: In the current market, borrowers typically only get about a 1/4 percent improvement in rate for paying a point. Hence, it takes about four years to recoup that point with interest savings. Borrowers often end up refinancing before they recoup their points, as discussed above and below.
Changing Rates, Changing Equity and Life Events: No matter how long people expect to keep their loans, we are always amazed by how soon they refinance for a variety of reasons, including the following:
- Rates fall sooner than expected (like what we saw this year and numerous other times since 2009) making a refi make sense no matter how many points a borrower paid;
- The equity in their home increases and they want cash out or they want to eliminate Mortgage Insurance; and
- Life events such as job changes or family size changes require different housing needs.
Fed Can’t Raise Rates/Weak Economy: The Fed has tried to push rates to the lowest level ever in order to combat economic damages caused by the COVID-19 crisis. The Fed is not the sole driver of mortgage rates, as I mention often, but it does still influence rates in a significant way. Moreover, the Fed’s hands now seem tied in that it has to keep rates low in order to keep asset prices inflated.
Unscrupulous Lenders: Many lenders convince borrowers to pay points for rates that they probably could have obtained at “no points” at another lender. These lenders convince borrowers that they are paying “discount points” to buy down the rate when the borrowers are really just padding the lenders’ overall commission.
Cash Is King: One more reason not to pay points is that it requires more cash to close, and for many of our borrowers, cash is all too tight in the first place. In addition, it is simply advisable to remain more liquid for a variety of reasons – home improvements, investment opportunities, unexpected expenses, lay-offs, etc.