Navigating Origination Fees And Points

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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