Navigating Origination Fees And Points

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When you go to purchase a home using a mortgage, one of the major expenses that you’ll have to pay at the close is the origination fee. Here’s a guide for navigating them and figuring out what the best deal is for you.

What’s an origination fee? The origination fee is an amount that you pay at closing to the group handling your mortgage. This fee varies a lot from mortgage handler to mortgage handler and is typically expressed in “points.”

What’s a “point”? A “point” is one percent of the total cost of the mortgage. So, for example, let’s say you have a $190,000 mortgage. A “point” is one percent of that, or $1,900.

So, aren’t less points better? It depends entirely on your financial situation. Quite often, when you get a mortgage, there will be multiple options with different origination fees. Let me give you an example that’s roughly similar to my own mortgage.

A loan officer is about to lock in your 30 year fixed rate loan for $200,000 and offers you three options:
A mortgage with no points and a 6.25% interest rate
A mortgage with one point and a 5.875% interest rate
A mortgage with two points and a 5.75% interest rate

The first thing to do is to calculate the actual payment you’ll have to make with each loan:
The 6.25% loan will have a monthly payment of $1,231.43 and over the life of the loan you’ll pay $243,316.38 in interest
The 5.875% loan will have a monthly payment of $1,183.71 and over the life of the loan you’ll pay $226.137.30 in interest
The 5.75% loan will have a monthly payment of $1,167.15 and over the life of the loan you’ll pay $220,172.46 in interest

Clearly, the lower interest rate loans will save significant money over the life of the mortgage. However, you’ll have to pay the following at time of close:
With the 6.25% loan, you’ll pay $0 at the close
With the 5.875% loan, you’ll pay $2,000 at the close
With the 5.75% loan, you’ll pay $4,000 at the close

How much is my payment reduced? Many people want to know how much they’ll save on monthly payments if they cough up the points. In this scenario, if you cough up one point, your monthly payment will be $47.72 less than if you coughed up no points. If you put up two points, your monthly payment will be $64.28 less than if you coughed up no points, and $16.56 less than if you coughed up a single point.

When do I break even with points? With that 5.875% loan, you’ll make back the $2,000 in reduced payments in 42 months; with the 5.75% loan, you’ll make back the $4,000 in reduced payments in 62 months. This calculation is easy – just take the origination fee and divide it by the difference between the large payment and the small payment.

Once you’ve done these numbers, the appropriate option for your finances will become pretty clear. For us, we took the maximum number of points offered to us because it was clear that in the long run we would pay significantly less to the bank and lower mortgage payments means more breathing room in our monthly budget. For others, it may make sense to take the middle road or perhaps to pay no points at all, but be sure you sit down and really calculate the numbers before you make the leap.

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18 thoughts on “Navigating Origination Fees And Points

  1. Consider Negative Points

    I bought a house in Aug 06 with no points and your typical closing costs. At this time interest rates seemed to be on the move up. However, I ended up just hitting a peak. 6 months later I took advantage of a no cost loan – (essentially negative points) It was little higher interest rate (compared to one with closing costs) but that was still 0.5% less interest rate than my original Aug 06 loan.

    I didn’t like “wasting” my original loan’s closing costs. I would have saved a couple of thousand dollars if I started with the no cost loan and refinanced later. So instead of buying points you might be able to take advantage of a free lower interest rate in the future (before you break even). No one knows the future but it worked out that way for me.

    PS. To reduce my required monthly payment I took out a 20% second loan that I plan to pay off in

  2. PS. To reduce my required monthly payment I took out a 20% second loan that I plan to pay off in

  3. Sorry – doesn’t like less than lessa than sign

    PS. To reduce my required monthly payment I took out a 20% second loan that I plan to pay off in less that 2 years. I did this in anticipation of a having kids with only 1 income.

  4. When deciding whether to pay points, you have to take into account how long you expect to have the mortgage. If you sell the house or refinance before you’ve recouped the points, you’re on the losing end. Many people, especially first-time homeowners, don’t stay in the same house long enough to make paying points worthwhile.

    Also, $4,000 is a lot of money to risk upfront to save $65 a month. People fret so much about interest rates and shaving an eighth or a quarter of a point off the rate, but such small rate changes make little difference in the monthly payment. Yes, when you look at the total interest paid over the full life of the loan such small rate changes seem significant, but very few people will keep the mortgage that long. Those numbers are essentially meaningless.

  5. Also, you ignored the fact that if you kept the $4,000 you would be making money on it. So your real savings are actually less than what you stated. That $4,000 making 8% could earn as much or more than you’re saving on mortgage payments over 30 years.

  6. You’re spot on, Matt. That’s why I mentioned calculating the “break even time” on any points one is considering taking. For us, the break even point was about three years and we anticipate living in this area for a very long time.

  7. Trent – I, too, fully expect to live in the same area for a very long time, but I don’t expect to stay in the same house. In fact, we just sold the house we bought 5 years ago (and refinanced twice) even though when we bought it we thought we would stay until the kids were grown. Will we stay in our new house for 10 or 20 years? I’m no longer naive enough to think that’s true. I wouldn’t bet $4,000 on it, that’s for sure.

  8. On the other hand, Matt, let’s say it was more important to me to be debt free than to invest that $4,000. If I pay the points up front and then take that extra $64.28 a month into extra principal payments, I shave almost four years off of the life of the loan.

    There are lots of ways to flip those numbers around, and the correct decision depends on what your financial goals are and where you see yourself in the future.

  9. There are also tax considerations. It gets complicated depending on your tax bracket and if you itemize. By lowering your interest rate you will have less interest to deduct. This is not necessarily bad because you’re sending less to the bank. On the other hand, points paid are not deductible in their entirety in the year paid. They are supposed to be amortized over the life of the loan.

    As mentioned above regarding refinancing, you’re placing a big bet that interest rates* are going to rise or stay flat until you reach the break even point.

    *(Note that lenders still consider rates to be low compared to historical levels.)

  10. It truly does depend on the individual. If you are planning on staying in the house a short period of time, paying off the mortgage early (or earlier), and your tax rate (as discussed earlier by Ted V.). If you honestly believe that spending extra money now during closing will impact your ability to pay your regular bills too — some would advise not paying the points. If you have a variable rate, that’s another major consideration.

  11. I closed on my house in November, and paid 1.5 points, which allowed me to deduct some money for my 2006 tax return. I hadnt gotten points I wouldnt have been able to itemize on my return.

  12. Alex – Itemizing deductions is not the windfall many seem to think it is. I would much rather pay no deductible expenses and take the standard deduction (thus getting free money) than pay a bunch of deductible expenses and get a fraction of the money back. It’s nice when something you had to pay anyway is deductible, but buying a tax deduction for its own sake is never a good idea.

  13. Matt,
    You have a legit point. I chose points b/c it made sense for me, given my plans to stay in the house and to take a lower paying job in the future, to have lower monthly payments. I was just pointing out that the upfront costs can be additionally helpful if you close at the end of the year, as it will allow you to itemize.

  14. It is worth considering if you would be better off in the long run just paying an additional 4k down on the principal to start with. In other words, instead of taking a 250k mortgage, figure the total interest paid compared to a 246k mortgage. If you plan to stay long term it may work out to be more affordable this way. It has the additional advantage of working in your favor no matter how long you carry the note, whereas the benefit from paying for points is inherently tied to the duration the loan is held.

    I’m personally not fond of paying points on a mortgage. It seems like there are plenty of other creative ways to rework the deal. My gut says that the bank and their team of actuaries have figured out that selling points on average works in their favor, otherwise they wouldn’t offer it.

  15. Caveat: I own a mortgage company.

    When calculating whether or not to pay points, you must calculate or estimate not how long you will stay in the house, but how long you will stay in the LOAN.

    The points are a interest rate risk hedge against the LOAN, they have nothing to do with the actual house

    The reason I say this is many people justify paying points on whether or not they plan on living in the home for a specified period of time. That doesn’t matter. What matters is how long you anticipate keeping the loan. Yes you may move, but you also may refinance, make a large principal reduction, prepay you loan, remove PMI or any number of other moves that must be accounted for.

    The simple facts are most people keep their LOAN for about 4 years, and approx 2% of those paying points come out ahead by doing so. 98% lose.

    Love the site.

  16. Points upfront are not being treated correctly here.

    $4000 has to be treated like any other form of money. It could be placed into high yield investments. Also taxes have to be calculated.

    A simple return of x months is wrong.

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