Points – To Pay or Not to Pay: That is the Question – Part 2

 

In the last article, I showed that lenders offer many rate-versus-fee alternatives, not just the one you are likely to be quoted.   Anyone who is going to be in the home for a long period of time – not all, but lots of people – paying points is a terrific opportunity to save money. In fact, I look at it as the only good thing about the process.   Everything else costs you money, but this is a way to get it all back by getting a lower rate and saving a lot of interest over the years of ownership.

 

I’d like to spend a minute talking about no-point and no-cost loans.   First, there is no such thing as a “no-cost loan.”   I want you to imagine a lenders office where they are having a meeting about the loans in process.   The manager says, “Note that the Smiths want a no-cost loan, so call the appraiser and the title company and the attorney and tell them not to charge for it.   Oh yes, and of course none of you will get paid on this loan.”

 

The fact is that all of the costs on a no-cost loan are exactly the same as any other loan.   The appraiser charges just as much, and so does everyone else.   It’s just that the borrower doesn’t write a check for it, so from his perspective, it looks as if he’s getting something for free.

 

The questions are, “Who does pay the costs?” and “Why are they willing to pay them?” These questions are baffling to most people, and understandably so.   After all, in a restaurant, you don’t volunteer to pick up the tab for the couple at the next table. You don’t tell the guy at the next gas pump that you’ll buy him a tankful of gas. It must be so   baffling that people don’t even seem to want to try to figure it out. But I want you to know, so here are the answers!

 

The first “who” is the lender with whom you are dealing.   Remember, though, that this really isn’t the lender because they sell your loan.   FannieMae, FeddieMac, and Wall Street money sources that buy almost all loans these days are the second “who.”   They actually don’t care about cost or no-cost; they are just willing to pay more money for higher rate loans.  

 

Say you are a retail lender and you have a 6.25 percent loan and the “market” is at 6 percent.   That 6.25 percent loan is worth more to Wall Street and they will actually pay $101,000 for a $100,000 loan.   Thus, as originating lender, you will make an extra $1,000.   A 6.5 percent loan is worth $102,000. You gave the borrower $100,000, and you sold the loan for $102,000, making $2,000.  

 

You can see that because borrowers are willing to pay a higher rate, the lender makes extra money. Whatever the sum, they use this extra amount to reimburse themselves for the costs that they paid on your behalf.   If they know that the costs associated with your loan are going to be $2,000 and they know you want a no-cost loan, they will quote you 6.5 percent, knowing they will get an extra $2,000 to cover the costs they paid on your behalf, and they’ll come out OK.

 

The answer to “why” is, of course, “GREED!”   There is a lot more money in those interest payments than your costs that they paid.   I’m sure you’ve heard, “We raise the interest rate slightly.”   Not true! By using the word “slightly” they are intentionally using language to deceive you.   People will accept a word like “slightly” without much question whereas they recoil from a word like “gouge,” as in, “In return for paying your fees, we’ll gouge you on the rate.”   That sounds harsh, and no one would go for it, so they use the word “slightly” instead.  

 

To generate that $2,000, you had to pay 6.5 percent, not 6 percent.   Your lender got his $2,000 back.   Now the money source that came up with the $2,000 is going to get an extra one-half percent in interest from you, $500 per year. If you have the loan for ten years, they make about 10 x $500 = $5,000 in extra interest.   Let’s see, they fork over $2,000 and make $5,000.   Folks, it should be obvious that this is a VERY profitable transaction, which is why they are so willing to do it.

 

This seems as if they have a great racket going here.   They make an acceptable profit on the loan and then they have this terrific side business lending borrowers the money for the points and costs.   Borrowers are paying billions in extra interest every year, and what is ironic is that they actually think that they got the better part of the deal. They don’t realize that if THEY paid the costs themselves, THEY would get to keep that $500 every year. It would be insanely profitable for them instead of the other guy.

 

Be careful out there.