Home Mortgage Essentials: Understanding Points

An Introduction to Points

Understand first that your mortgage broker is in a profit-making business, and her first concern is to make money. This lets you know right off the bat that there is no such thing as a free loan. Not only are there interest rates to deal with, but there are other fees involved your total cost and very little in the way of standards to regulate them. One of those things is the “point.”

How Loan Officers Work

Loan officers are paid by commission and split the fees with their brokerage firm. So from the time you fill out your application, they are working out ways to make money above and beyond the interest rate, and this process begins with your application fee (or loan origination fee). So unless you have bad credit, if a broker insists on this fee up front, be suspicious. Most mortgage brokers charge the going interest rate plus a point origination fee.

How Points Work

And what is this omni-present “point?” A point equals 1% of your loan amount. So if your loan amount is $100,000, a point for you is $1,000. With some mortgage brokers you have the option of paying this in the loan amount, but that means you are adding interest payments—over time the interest on that $1,000 adds up to quite a bit. If you can, pay this up front so you save that interest money and you can deduct it come income tax time.

Points and Government Loans

On government secured and guaranteed loans—FHA and VA—the buyer does not pay the points, the seller does. Even with other types of loans, it would pay to negotiate this with the seller through the purchase price.

Points on the Back

One type of point system to watch out for is what some brokers call points on the back, or yield spread fees. This is where brokers and loan officers make extra money by selling loans that are a higher interest rate—some say it amounts to a kickback for selling a more expensive loan. They frequently do this with those who can’t afford their loan costs. By adding a percentage point onto the loan, they make up their fees. Over time this costs a borrower dearly.

Legal Considerations

Although tricking borrowers into paying higher fees is illegal, it’s a difficult area to judge. Even HUD stated in 1999 that it depends on the circumstances of each borrower-broker relationship. This is unfortunate, because an unwary borrower who may be a little short of cash can be victimized by this technique—so can the borrower whose broker “forgets” to tell her about the “additional” closing costs or fees.

Do Your Homework and Shop Around

Do your homework as well as your shopping, especially if your credit is spotty. People with bad credit are often taken advantage of in the mortgage market. Regardless of your category, insist on full disclosure of closing costs and fees from your broker, including yield spreads. Even if you think you know what it all means, make them say it to you in plain language.