points and fees

points and fees
	Points and fees vary widely among lenders and loan programs Opt for a no point and/or a no fee loan when doing an adjustable or short term fixed rate.

what they are? Points are referred to as a loan origination fee, and are expressed as a percentage of the loan amount. Thus, for a $500,000 loan, a 1 point origination fee would be $5,000. Points usually range from .05% -2% of the loan amount. Lenders charge points in order to achieve a certain rate of return on the funds being loaned and / or to pay for operating expenses.

Other loan fees, known as closing costs, would include: title insurance, escrow service, loan processing, appraisal, notary, and loan documents. These fees vary depending on the loan amount but usually range from .25%- 3% as a percentage of the loan amount. For a $500,000 loan, these other closing costs would equal about .75% or $3,750. Thus, if your were quoted 1 point plus closing costs for a $500,000 loan, your total closing costs would be about $8,750.

should you pay points and fees? Points and fees are inversely related to the interest rate on the loan. Thus, the higher the rate, the lower the points and fees and vice versa-- all else equal of course! In the last several years, many pricing options on both fixed rate and adjustable rate loans have enabled borrowers to minimize the total cost of borrowing (total interest over the duration of the loan plus points and fees).

Deciding to pay points and fees or take a no point/ no fee loan depends on:

*How long will it take you to recoup paying points vs. not paying points?* As an example, assume you want a $500,000, 30 year fixed rate loan. The pricing options for this loan are:
	Option A: 7.25% with monthly payments of $3,411 with no points or;

	Option B: 7% with monthly payments of $3,327 with 1 pt ( $5,000)

The amount of time to recoup the $5,000 ( 1 point) is calculated as follows:

Points expressed as dollars/Payment on Option A less payment on Option B (1 – your combined Federal and State tax bracket)*

So, for our example, the time to recoup would be:

91 months or 7-8 years, by using the formula below:

$5,000/($3,411 - $3,327)X (1- 0.45)

Thus, if you were confident you would keep this loan for at least 7-8 or more years, you would choose Option A and pay the point.

Since the time to recoup is usually about 5 years for most short term fixed rate loans of 7 years or less, it's not beneficial to pay points for these loans…. Why pay points when the time to recoup is about at the time when the loan would be converting to an adjustable.

* Note: since interest on a home loan is usually tax deductible, this allows you to convert this formula to an after tax basis. We’re assuming a combined tax bracket of 45%.



*What is your forecast for interest rates?* If you think rates are likely to go lower during the time it takes to recoup points, you would not want to pay points since you could end up refinancing this loan.