I was seriously tempted to hijack the “Bank Intrest Rates” thread with this question, but I was afraid (1) it wouldn’t get the reponse it deserved, and (2) I’d get yelled at for hijacking. So instead I just stole part of the thread title.
Now let’s talk about those points. What the hell are points, anyway? Just another excuse for a bank to soak you, or do they really pay for some specific service? According to the realestate glossary, points are
But banks already have loan origination fees on the loan contract, so what exactly do points pay for? I’ve only ever closed one mortgage (about ten years ago) but I still remember all of the various assorted fees.
• Loan origination fee
• Title search fee
• Coffee & danish at the closing ceremony fee
• This fee
• That fee
• The other fee
• etc…
It seemed like there was no end to the fees. And after all those fees, there were still points!
I think that points are a recent invention by banks… or are they? Have banks always charged points (on top of all the other fees)? What’s to stop them from deciding that as of January 1 2002, for no specific reason, all consumers will have to pay “bleens”, which are equal to $100 multiplied by the relative humidity in Biloxi, Mississippi?
Points are kind of like prepaying interest. You can get a no-points loan, but the interest rate will usually be higher than a loan with points. Banks charge points because they get the money up front when you pay points, as opposed to the tiny bit more each month that they get when your interest rate is slightly higher. It may be a good idea to pay points in exchange for the lower rate, but you have to compare the points-loan total amount interest paid plus points versus the no-points loan total amount interest paid, over the full length of time you’ll be paying the loan, to determine which is the better deal. If you’re short on ready cash or you’re not planning to be in the house for a long time, no-points loans will probably be the best deal for you. If you’re going to stay in the house 30 years, paying point to get a lower interest rate will probably save you lots of money over the long term.
Points were invented (or came into widespread use if they were invented earlier) during the late 1970s and early 1980s. At that time, high inflation meant that a long-term loan would be overwhelmed by the depressed value of the money.
Borrow the money at 10%. Inflation runs at 10%. Pretty soon the bank must borrow money from the Feds or other banks at a higher rate while the money coming in from older loans will not cover the costs of the money.
The banks decided that they needed to recover some of that money up front, so they added “points.” Now they don’t really get that money right away (because if you had that money, you would have lowered the amount you borrowed by that much). However, they do raise the amount on which you are paying interest. If you borrowed $100,000 at 10% and they charge you 5 points, you wind up paying back on $105,000 even though they kept the $5,000 on which you are paying. You are paying them to hold their money that they will not let you use.
Of course, having established the points as an “accepted” fee, when inflation dropped to a negligible amount (and they dropped the amount they paid investors from 15% to 3%), somehow the points never got dropped from the equation.
So, basically, it was an economic necessity to keep the banks afloat in 1980 that is simply gravy they are stealing from you, now.
Points aren’t a recent invention from my experience… I bought a house 20 years ago and had to pay points on my loan. Think of it this way… banks can offer lots of different products (loans) at different costs to the consumer (you). Two variables they can change are the Rate of the mortgage and the Points you have to pay. So if you want to borrow $100,000 from a bank nowadays you can probably get a loan at 7.0% at no points, 6.75% at one point, and 6.5% at 2 points. In other words the cheaper the interest rate, the more you have to pay for it so the higher the points. I have refinanced my house a number of times and I have always gone for the no points, no fee deals which don’t have the best interest rates but don’t cost me anything either. I could always “buy down the loan” to a lower rate by paying points but on a $650,000 loan in my case a point is $6,500.
Why they are called points and not just loan fees or some other name is beyond me…
This is why it is useful to know some math. I am surprised how even people who work with loans really cannot analyse these things.
Some years back the Feds outlawed prepayment penalties. Lenders on the other hand, hate to go through the whole process of approving a loan only to have you prepay it shortly after. So they put their heads together and their effort bore fruit in the form of “points” which are just a prepayment penalty by another name.
Anyone with a spreadsheet can work it out. Here’s an example:
You get a loan for $100000, 360 months, 9% interest, 2 points. Your monthly payment is $804.62.
In reality you did not get 100,000 but 98,000. so consider this: A loan for 98,000, 360 months, 9.2275% interest, 0 points has the same monthly payment of $804.62. If you repay the loan back over the full life of 360 months, that is what you really got.
But if you prepay it at, say 180 months, in the first case you owe 79120.84 and in the second case you owe 78483.35 so your prepayment penalty is $847.
THAT is why a bank prefers to call it $100000, 360 months, 9% interest, 2 points rather than 98,000, 360 months, 9.2275% interest, 0 points even though it is the same loan.
With a spreadsheet you can easily analyse all these things. (at least I can)
astro, I know the answer. I just wanted to see if anyone else can give me an answer and we could discuss both answers.
Another discussion which I’ve had a number of times is with people who say owning is always better than renting. Their reasoning: renting you end up with nothing, owning you end up with a house, therefore owning is better than renting. Duh!
Of course this argument is so flawed in so many places I do not know where to begin. But it has the beauty of its simplicity for people who are math illiterate. (But this would be an entirely different thread)
I can’t give you an answer on which is the “better” loan depending upon interest rates and number of points. For one, I’m not that good at the math.
But second, it depends on what you’re looking for. If you want lower payments per month, you may want to buy the points. But it’s not just the lower payment that may matter, it also depends upon how long you plan on being in that house.
I just bought a house, so I went through this rigamorale. Generally, I paid the bank $2,800 to buy 2.75 points. This lowered the interest rate. To pay off those points, that is, to make up the difference between the higher and lower payment, we will have to stay in the house a minimum of about 7 years, which we plan on doing.
There is another benefit to us as well: we plan on paying off as much of the house as possible, so if we make payments at the rate we would have had (had we not bought points), the money will got into paying off the principal. This will reduce the amount of interest we will pay into the house over the long haul, and enable us to pay off the house earlier than 30-years.
So why try to pay off the house early? We’re thinking forward to retirement, and not having the monthly payment will make it much easier for us to live on our savings. Whatever gains we may have on deducting interest payments will be more than made up in other areas.
It’s the same reason why I still have my 1990 Ford Festiva, six years after I paid off the loan. By paying it off, I’ve essentially am paying myself the extra $110/month that had gone into car payments.
A trade off for a lower rate, now it becomes a little clearer why they call them points - lower your rate by a point if you pay it (the point) up front (although I don’t think it’s 1-for-1 any more). The seller paid the points on my mortgage ten years ago, so I was not in the position where I needed to argue about them. I just have always wondered what they were.
Next time I make a home purchase, I will do so armed with my spread sheet.
Today I got an offer on my home. They offer above my asking price but then demand 3% in “closing help”. This is just ridiculous and IMHO should be illegal. By showing a higher (and quite ficticious) price, they can get a higher mortgage. Rather than offer (say) $150,000 they say "we’ll give you $155,000 with the condition you give us $5000 for closing costs, points, whatever. This is outright scamming. The realtor is happy because he gets more commission. The city is happy because they get higher taxes. The bank is happy because they make a bigger loan (except the property will not cover a default now). It is plain cheating. Close to what cyberrebates was doing. I mean these people could say “look we’ll give you $5 million for your property with the condition you give us back $4,850,000”. This is just creative accounting to get around the rules limiting the amount of the mortgage. I rejected the offer anyway because they did not look solid at all.
I wouldn’t call it scamming, exactly; it can be invaluable to people who are a little short on their ready cash and it can get you a buyer in a slow market. You don’t have to take it, after all. Some sellers freely offer to pay closing costs, points, etc., as a way to entice buyers (who often are short on cash). It’s up to you to determine whether 155k less 5k cash paid out is worth more of less to you than leaving it on the market to see if you get a better offer. A 5k difference may not trigger an overvaluation panic from the bank, but that’s another chance you take. It’s all part of the art of the deal, IMHO.
Gaudere, you can call it what you will but let’s get real, it is cheating pure and simple. If the percentage is small then your are cheating a little, but it is still cheating. The only purpose of this operation is, by misrepresenting the value of the house, to get a higher mortgage than would be allowed. If I give you my house and $5000 for $155,000 then I cannot say with truth that I sold the house for $155,000. What I got for the house is very clear.
>> Some sellers freely offer to pay closing costs, points, etc., as a way to entice buyers (who often are short on cash).
Well, yes, but they are lying to the lender by misrepresenting the true sale value. If the lender wanted to lend you on the house more than the house is worth, he’d do it. There is no denying that the object of this practice is to get around limits on mortgages by inflating the apparent value of the sale.
I could also entice the buyer who is short on cash to go rob a bank and that would solve my problem of finding a buyer. it’s still wrong though.
Just as I explained points are a way of getting around the prohibition of prepayment penalties, this is a way of getting around loan limits.
These things go on and everybody winks and looks the other way until something like the Savings and Loans debacle comes along. Then everybody starts pointing fingers and they all say “well, everybody was doing it!”
