Paying points can be a smart move
Of the many mysteries surrounding mortgage brokers, how we get paid is perhaps the most misunderstood. As a mortgage broker, I am paid by points charged up front and/or within the interest rate. One point equals 1 percent of the loan amount. Points are prepaid interest used to buy down an interest rate, and they are charged up front. Points are rolled in with all other applicable closing costs and paid at closing. Per my job title, I broker mortgage money. Thus, my investors pay me a certain percentage based on the mortgage money and the interest rate that I sell. For this article, lets examine paying points on the front end. If used in the right manner, points are paid in lieu of a higher interest rate and to lower monthly mortgage payments. Modern day media has done a good job of putting consumers on guard against any junk fees or points that mortgage brokers may be charging. Generally speaking, this is a good thing as there are indeed numerous crooked mortgage professionals charging unnecessary junk fees including points. However, there are just as many scenarios in which points are a wise and prudent use of ones money. In the last few months, I have charged clients points, or a percentage of a point, in many advisable scenarios, keeping their interest rates low. My clients have paid points to offset rate increases that would have been incurred from such variables as a 90-day interest rate lock, a stated income loan program, an interest-only loan and jumbo loan amounts. All of these examples present additional risks to my lender, resulting in higher interest rates. The money paid up front in the points offset the increased rates.I also had one client pay a point up front when there were no negative factors causing interest rate increases. As with the other examples, the client did this in order to reduce the interest rate as much as possible. In order to determine if paying a point up front is advisable for a client or not, relatively simple math is used. The calculation is called a breakeven analysis. Any time I am proposing a client pay points up front, I review and discuss this calculation with them. The cost of the point is divided by the saving between the two interest rates.Lets analyze a $200,000 loan with an interest-only payment, for simplicity’s sake. Two arbitrary options for a client may be an interest rate of 5.75 percent with 1 point paid up front vs. a rate of 6.125 percent without any points up front. The cost of the point is $2,000; the rate of 5.75 percent will carry a monthly payment of $958.33; the payment at 6.125 percent will be $1,020.83. The difference in monthly payments is $62.51. The 1 percent point costing $2,000 divided by $62.51 (the difference in monthly payments) is 31.99. If the client and I foresee the mortgage being kept for more than 32 months and the client has the money or equity to do so, the point should be paid. After 32 months, the cost of the point will be recouped in the monthly savings, making this an advisable and wise financial move.It can be quite difficult to answer whether or not a client will be in the mortgage for the necessary amount of time. That is the tricky part of the scenario because it asks difficult questions pertaining to a clients personal plans and the direction of financial markets. I have seen breakeven calculation be as short as six or seven months and as long as 85 or 90. Regardless, the option should always be discussed because it is a viable and often wise financial move.If properly used, paying points can financially work to your advantage and have tax benefits. Points are completely tax deductible on purchase transactions and amortized over the life of the loan with refinances. In fact, I even charged myself a full percentage point on my last loan, and I encourage you to ask me why!William A DesPortes is a managing member of DesPortes, Selig & Associates, Professional Mortgage Services. He can be reached at 970-949-0653 or firstname.lastname@example.org.Vail, Colorado
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