The Secret Behind Points And Closing Costs: What You Should Know
Should you pay points?
What are points?
Is that money going directly into the Loan Officer’s pocket?
Well, that depends. This article will look at these questions as well as a few others to see which strategy makes the most sense in the long run. We’ll also look at the math to calculate when points make sense and when they don’t.
The Secret Behind Points And Closing Costs: What Are They Exactly
Let’s start with the definition. A point is 1% of the loan balance. So if you’re getting a $500K loan, one point is $5000. The ‘standard closing cost structure’ will include one point. In fact, the first point is referred to as ‘origination’.
The Secret Behind Points And Closing Costs: Origination Fee
The origination is the fee to ‘originate’ the loan. So that first 1% goes directly to the Broker. And depending on your Loan Officer’s volume, he or she will get some percentage of that money.
The remaining portion pays for the lights, the office space, the furniture, photocopier and so on. Part of that money goes to the Loan Officer and the rest pays for the office. That explains the origination.
Anything beyond that is referred to as ‘points’ and points are actually prepaid interest; money that goes directly to the Lender. And in exchange for that prepaid interest, the Lender offers a lower interest rate, lowering your payment.
We can calculate the break-even for the decision. You either pay more up front and get a lower payment or you pay less up front and get a higher payment.
The Secret Behind Points And Closing Costs: What do The Numbers Say
Before we look at the math, we have to address a couple of issues. For starters, the points and origination are tax deductible so they don’t cost you as much as it may appear at first blush.
If you’re getting a $500K loan (1 point is $5000) and depending on your tax rate, that point may only cost you $3000 or $3500 on an after-tax basis.
You’re either paying that money to the government or you’re using it to buy down your interest rate. When calculating the break-even, always use the after-tax cost.
The Secret Behind Points And Closing Costs: Another Thing To Consider
Secondly, one point buys different amounts depending on what loan you’re getting. If you’re getting a 30-year fixed mortgage, one point will reduce your interest rate by about 0.25%.
With loans that are fixed for 5 or 7 years, one point will reduce your rate by about 0.375%. These are not exact figures. They vary by lender and by program.
If you’re getting a 2-year fixed loan, one point would reduce your rate by a full 0.50%. The shorter the fixed period, the more one point will buy.
The Secret Behind Points And Closing Costs: Stay Tuned For Part 2
We have covered a good amount of information in this article. However there are more secrets to be unleashed as we progress along in the series, “The Secret Behind Points And Closing Costs“. So be sure to look out for part 2 of this series. Till then Take care and have a great day.
Take Care And Have A Great Day
Dr. Gregory Stargell II
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