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Hi rmonson,

You asked;
We are considering refinancing. My parents tell us never pay points on a mortgage, but when I suggest this to lenders they look at me like I'm nuts. What am I missing? Does anyone know of a lender that has a good rate (under 7.5) and doesn't require you to pay points?

"Points" means different things to different people outside the actual finance industry. Some people understand them to be strictly the discount fees you can pay to get a lower interest rate, some feel it counts towards the whole bunch of closing costs, some feel it represents the compensation to the loan officer or banker. I'm actually in the business, and I can tell you they are all somewhat correct, but only partly...

Every different type of mortgage loan has three basic Money Parts...
1) the interest rate,
2) the Yield Spread (or discount points, or rebate, etc.),
3) the real, cash closing costs paid at closing.

You could think of these as three sides of a triangle, with the area inside the triangle being the real costs of the transaction. The inside area is somewhat negotiable, but only to a point, as nobody will work for free, and there's a lot of people involved in making the loan close. Still, the public usually only focuses on one or two sides, so the industry adjusts the remaining side(s) to allow the costs to be covered.

The public is aware of the interest rate, of course... but the confusion comes from the thought that the interest rate is the ONLY variable, therefore a loan could be shopped by comparing rates only. Of course, that's not the case at all.

The 2nd thing the public becomes a little more aware of are the closing costs. These include fees for a plethora of things that have to be done to get a loan accomplished, including appraisal, title search and insurance, closing agent (escrow), origination, processing, underwriting, tax service, recording, credit report, document prep, and another half dozen minor things.

The 3rd side to the triangle is the yield spread premium... also known as the discount points, or the rebate points. These change daily, sometimes several times a day... and actually determine what interest rates you will hear about when you shop.

Here's an example;
Let's look at a $200,000 mortgage...

The real, cash closing costs necessary to pay all the players involved will run about $4,200 to $4,500. Now I can already hear readers murmuring about how high that sounds... but trust me, that IS how much cash is actually paid to the professionals that do the deal when it gets done... it just rarely is disclosed to the public because the public can't stand to see teh real view of that side of the triangle... so it's camouflaged by shifting the following sides.

Sides 1 and 2 are the rates and fees (yield spread)...
Here's what these were for a 30 year fixed, conforming loan from one of the largest national wholesale lenders today (by the way, I can't mention the name, though you would know it, because BY LAW I'm not supposed to publish the real wholesale rates to the public because "it would screw up the game..." I don't believe in "The game!")

Rates - Fees
7.125 .500
7.250 .125
7.375 (.250)
7.500 (.500)
7.625 (.875)
7.750 (1.125)
7.875 (1.250)
8.000 (1.500)

You could have locked ANY of these rates on the left. If you chose to lock at 7 1/8% (7.125), you would be required to PAY discount points of 1/2% (.500). If you chose to lock an interest rate of 7 1/2% (7.500) the LENDER would pay discount points of 1/2%

Now, you see, these ratios change daily. Today, for example, at one point the interest rate of 7.125 had 000 discount fees... or was at what we call "Par." That means that no money changes hands in either direction at that interest rate. By the end of the day, as you can see, the interest rates and fees had fluctuated such that the same interest rate now COSTS 1/2% of a discount point to lock.

Rates and fees fluctuate UP just as quickly as DOWN... and you never know which way they are going to trend.

A common "Bait And Switch" trick the public insists on having the industry play on them goes like this;
1) The ads say "No Points Loans," and "Zero Fees Loans,"...
2) Johnny Public says "free is for me," and gives 3 or 4 a call "to shop rates" thinking he'll choose whichever quotes him the lowest rates "at no points."
3) Every banker and lender KNOWS this about Johnny Public, and they KNOW that Johnny has NO CLUE about how fast things change in the industry... so they tell hime WHATEVER they think he wants to hear and will believe in order to get him to come into THEIR bank or business to begin the process of the loan application,
4) Once Johnny chooses his bank or broker, he pretty much pats himself on the back and hunkers down, thinking the shopping game is over... and the loan officers KNOW THAT about Johnny...
5) Rates slide up a little bit, and the loan officers tell Johnny about the market volatility and how his loan is going to be just a little more than originally quoted... but "hey don't worry... it's still great, and we're still better than all those other guys..."
6) Rates slide down a little bit... but nobody bothers to tell Johnny, and Johnny doesn;t have a clue. Even Johnny the web-savvy technician is in the dark because the wholesale industry doesn't keep the real, updated rates and fees available online to the public. Only the brokers and bankers can access them with their passwords, as they are forbidden by law to disclose the real market prices to the public (again, it would spoil the game.)
7) Because rates slid down, the corresponding yield spread points go UP... but again, nobody told Johnny he has money coming back into the deal (gee, I wonder why?),
8) Even more fees are available, contributed into the closing by the lenders according to their published wholesale rates, and even more money is being compensated to the Professional Team than Johnny originally negotiated to pay... And Johnny has absolutely no clue... but he's apparently happy because hey, he really worked these guys shopping a deal and he's gettin it practically for free!
9) Johnny COULD have actually closed his loan at a significantly lower interest rate had he simply chosen to pay the real cash closing costs and had the opportunity to benefit from the rising and lowering of the interest rates... but instead he played very shortsightedly, and got fleeced in the process.

Let's look back at the three sided triangle again;
1) rates,
2) Points,
3) Costs.

The only thng that has an absolute minimum, in reality, is the space between the three sides... and you can adjust the 3 sides anyway you want to.

Here's a "rule of thumb" to use for decisions;
A) Every cash-dollar paid by you at closing eliminates TEN cash-dollars paid by you in interest over the life of a 30 year loan. That means that if you pay $1,000 in points, you will be eliminating right up front about $10,000 of interest payments over your loan.
B) Every cash-dollar paid by the lender at closing (whether you're aware of it or not), ADDS TEN CASH-DOLLARS that you will pay in interest over the course of your loan.

NOTE: This rule is important to weigh in the light of the TIME INVOLVED!

Q: When should you have the lender pay all costs? (Zero points & fees.)
A: When you will only be using the loan for 7-10 years or less and the incremental difference of a slightly higher interest rate won't really matter... for example if it's your first home and you already know it's a starter and you'll be expanding for a family in the near future...

Q: When should you pay all costs in cash, but only the costs?
A: When you expect to stay with the same loan for 10-17 or 20 years at least. In this way the interest savings will pay themselves off against the usage cost of the cash you put into the deal up front.

Q: When should you pay all the costs in cash AND pay down the interest rate with additional discount points?
A: When you're truly making a long-term investment in your property and the monthly cash flow of the payments matters more than the short term cost of current cash.

I know this was a really long answer, lesson, and explanation... and I'd be very pleasantly surprised to find out that folks actually made it to the bottom of this piece. Hopefully it is helpful, insightfull, and profitable to the readers on these boards.

My greatest desire would be that all my potential clients KNEW this information before shopping for their lenders... my life would be so much easier, and my clients would end up so much less stressed and truly happier.

If you think this is valuable, let others know.

Dave Donhoff
Lic. Mortgage Broker
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