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Find Your LenderRefinance » Points v.s. Rates
When you hear about loan points, it is in reference to origination fees that are often expressed as a percentage of the loan amount. For example, a 1 point mortgage origination fee on a $250,000 mortgage is 1%, or, $2500. The 1% origination fee, or point, is a common amount charged by lenders to prepare your application, structure a loan program, pre-approve the loan, and ultimately get the final loan approval. It is often the largest closing cost associated with your mortgage transaction.
Origination points and interest rates have a noteworthy relationship that is worth discussing. In general, a loan with low or no points is going to have a higher interest rate than a loan with 1 point – or some amount of points. If you break it down, the reason behind that is quite simple. Lenders either make their money up front as a fee, or on the back in the interest rate. Whether or not you choose to take a loan with up front origination points, or one with no points, you should take the time to consider which option is best for you.
If you plan to stay in your home for a short period of time, a no point loan with a higher interest rate is a good idea. Because the origination point is considered a closing cost fee, it's quite possible that paying a higher interest rate over a short amount of time outweighs the benefit of a loan that has a lower interest rate and higher fees. Look at the table below for an example that shows a 30 year fixed mortgage (with and without points) making payments over a 12 month period:
| Loan Amount | Interest Rate | Payment | Origination Fee | 12 mo./s payments |
| $150,000 | 6.125% | $911.41 | $0.00 (0 points) | $10,936.92 |
| $150,000 | 5.75% | $875.35 | $1500 (1 point) | $10,504.20 |
You can see from the example above that the 0 point loan has total payments of $10,936.92 over a 12 month period. You can also see that the 1 point loan has total payments of $10,504.20 over the same period. The 1 point loan has yearly savings of $432.72 but you’ve had to pay $1500 in origination points to get those savings. It illustrates why a no point loan over a short period of time makes better financial sense than its 1 point counterpart.
$1500.00 in points MINUS $432.72 in interest rate savings = $1067.28 in lost, upfront fees that would have been realized as a savings had you chosen the 0 point loan with a higher interest rate. The loss only applies if you are looking at a 12 month period of payments where you might have refinanced or sold at the 12 month mark.
Now, if you keep the home or mortgage longer – long enough to recoup the origination points, the lower rate option will prove to be more beneficial. In our scenario, the 1 point loan with a lower interest rate makes financial sense as the best option if you keep the loan for more than 3.5 years. The breakdown is as follows:
Interest rate savings with 1 point loan = $432.72 / yr
Loan origination fee (1 point or 1%) = $1500.00
$1500 ÷ $432.72/yr = 3.47 yrs.
The upfront origination fee of 1% or $1500 is recouped in 3.47 years. After that, you begin to enjoy the $432.72/yr interest rate savings by paying the up front fee and taking the lower rate. If this is still confusing, your mortgage professional can provide a breakdown for your specific loan scenario.
It's important to note that there are different types of mortgage points. We've already discussed origination points - there's also discount points. Discount points are another type of fee that are paid to the lender to “buy down” your interest rate. It is a fee used to obtain an interest rate that a lender will only offer if you pay them for it. You can think of it like paying up front for the interest rate savings you will enjoy over the life of your loan. Just as origination points, this fee is expressed as a percentage. For example, if the rate available on a 15 year fixed mortgage is 5.75% and you would like 5.375%. You might have to pay the lender 1 discount point based on the loan amount to obtain that rate. Do not confuse discount points with origination points. In a situation where you are using a broker, the origination point will go to the broker while the discount point is paid to the actual lender. When using a bank, origination and discount points will go to the bank.
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