Closing Points, Origination Points, Discount Points ... What are points?

"I'm not paying any points!"

Well, okay then. I guess you're paying cash because everybody who borrows money from a broker, lender or bank (regardless of their misleading advertisement) pays points. Simply defined the word points means a percentage. What they are a percentage of is the next question. And, in this case, they are a percentage of the loan amount.

For example if we are talking about $100,000 and we say "one point" we mean "one percent" or $1,000 (one thousand dollars). If we say "two points" we mean "two percent" or $2,000 (two thousand dollars).

Since we know what a point is (1 point = 1 percent) and we know what it is based on (the loan amount) why exactly are points charged and why is it a good or bad thing? To the mortgage insider there are lots of points. There are origination points, there are discount points, there are yield points and there are service release points. Some of those points are directly visible to the borrower(s) and some are not so let's take them in order.

Origination Points - this is your loan officer's paycheck. She does not get it all (usually) but rather splits it with other people. Even if she does keep it all she has some other fees to pay out of it to her broker or lender. When people say, "this is a no point loan" they are not talking about this fee. They are talking about ...

Discount Points - this is the fee to buy the interest rate down. In plain language if you are offered an interest rate of 5.5% and you want the interest rate at 5% you will pay discount points or buy down points. On a purchase loan this may be paid by the buyer(s) or the seller(s) where permitted. Again 1 point = 1% of the LOAN AMOUNT. This is the fee almost everyone except mortgage industry participants are talking about when they say, "I'm not paying any points!"

The tricky part about "discount points" is it costs more than 1% of the loan amount to "buy down the rate" 1% - so you don't pay 1% of the loan amount to go from 5.25% to 4.25%

An example of discount points not intending to confuse: Say your loan amount is $100,000 and the interest rate is 5.25% but you want a rate of 4.625% - every loan officer will know exactly what these numbers mean. If they don't then they are not, in fact, a real loan officer. But I digress. The RATE column is obvious. The 25d column means once that rate is "locked" the file MUST be closed in 25 days or a rate lock extension must be purchased.

RATE     2d      10d     25d     40d
4.250  3.375  3.500  3.875  4.000
4.375  2.500  2.625  2.875  3.125
4.500  2.000  2.250  2.500  2.625
4.625  1.625  1.750  2.125  2.250
4.750  0.875  1.000  1.375  1.500
4.875  0.375  0.500  0.750  1.000
5.000 -0.125  0.000  0.375  0.500
5.125 -0.500 -0.375 -0.125  0.125
5.250 -1.500 -1.250 -1.000 -0.875
5.375 -2.000 -1.875 -1.625 -1.500

The -1.000 in the 5.250 row and 25d column means there is a cost to the borrower of -1% of the loan amount. Since the cost is negative one percent that means one percent comes back. Generally that would be shown on the mortgage broker's HUD1 as 1% of the loan amount in YSP. So if it is a $100,000 loan that would be $1,000 to the mortgage broker. You won't see it at all if it goes to the bank or lender.

The 2.125 in the 4.625 row and 25d column means the rate of 4.625% will cost 2.125 percent of the loan amount PLUS the 1% of the loan amount the broker won't be making. So in this case it will cost the borrower 3.125% of the loan amount to "buy down the rate" to 4.625% (there are many other ways to slice this pie but you don't have the patience and I don't have the time for the full book version :)

In the above example on a $100,000 loan to "buy down the rate" from 5.25% to 4.625% would cost the borrower $3,125 - on a refinance this could come from the new loan and on a purchase it can be paid by the seller or the buyer depending on loan guidelines.

Yield Points - called Yield Spread Premium, are probably the most maligned and possibly misunderstood "fees" there are. Funny thing is it's not a fee. What many bankers, bloggers and ill informed talk show hosts (plus a so-called "Real Estate Expert" on About.com) either do not understand or simply choose to lie to you about is these are the only "back end points" ever revealed to the borrower. Has YSP been abused? You bet! But bankers abuse rates and never tell you how much profit they are making. I know, I are one. I have also been a broker. If your rate is competitive you really should not care at all about these points. If you disagree or do not understand call me and we can chat.

Release Points - called Service Release Premium, are the most ignored points even though they are virtually identical to Yield Spread Premium listed above. For secondary marketers and mortgage bankers there is a huge difference between the two but to the end user really the are very similar. Both affect the interest rate paid by the borrower and the profit made by the lender/banker/broker. What should matter to borrowers is 5% 5.5% 6% - whatever the rate is and your other closing costs.

One of the big problems with mortgages is so many people have no idea how to shop for one. They think if they know the words, "points" "rate" and "closing costs" they know everything needed to know. What they really do when they ask those questions in the wrong manner is tell a savvy loan officer just how little they know. They would be better served by saying, "tell me about your mortgages and all the costs associated".

You are going to pay points one way or another. Either you are going to pay a higher interest rate, your loan amount is going to be increased or you are simply going to pay them exactly as they are.

Let me interject a note about "hidden fees". It is not that hard to have "hidden fees" on loans but even with "hidden fees" you can still shop if you look at the three most important numbers: How much money you have to bring to the closing table, your total loan amount and your monthly payment (and whether or not that payment can ever change). For example if your loan is $100,000 and you have to bring $10,000 to the closing table and your monthly payment is $500 for one loan but for another loan of $100,000 you have to bring $20,000 to the table and your monthly payment is $550 - YOU have to decide which one works for you. A true mortgage professional can advise you. Don't fall for some hopped up claims like, "all of our fees are up front" or "we have flat rate mortgage fees". So? So what? That in no way qualifies that company as more honest or trust worthy.

If you want to know how to shop for a mortgage, even if you are not in my market area, I will be happy to speak with you. Just give me a call and ask! Maybe I should write another post about how to compare mortgages ...

Ken Cook - Georgia - FHA, USDA, VA and Conventional Home Loans (678) 439-8683