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This Old House - Do-it-Yourself

Understanding Mortgage Rates, Points, and Fees

Written by Posted On Thursday, 30 March 2006 16:00

Freddie Mac pushes a lot of numbers, and one of the numbers they push is perhaps one of the most widely published … their weekly interest rate survey. Freddie Mac has people who contact 125 lenders or so, get their rate quotes on different mortgage programs, specifically the 30 and 15 year fixed, 5/1 hybrid and 1-year ARM, then publish those averages for all to see.

Not a bad way for the consumer to get a handle on just how their current or quoted interest rate stacks up with the rest of the country. Just this past week for example, the 30 year fixed rate average as reported by Freddie Mac was 6.32 percent, with 0.6 percent in points and fees.

This means the "average" consumer in this poll got a 30 year fixed rate at 6.32 percent and paid $1,200, or 0.6 percent on a $200,000 loan, in either discount points or lender fees or any combination thereof. Okay, that's pretty neat by itself. Nice of Freddie to do that, don't you think? I do.

Freddie has been doing this for a long time, since 1971. I think Nixon was President then. The highest this rate has ever been was 17.48 percent in 1982 (can you believe it!) and the lowest recorded was 5.23 percent in 2003.

But looking a bit deeper into those numbers, one trend is also definite: People are paying less and less in points and fees to get those rates. In fact, if you go back twenty years, the average points paid on a 30 year mortgage was 2.3 points paid on every 30 year mortgage. On average.

Again on a $200,000 loan that's $4,600. Okay, yeah rates were higher then (10.89 percent) so people paid more to get a lower rate but that doesn't explain why when rates were 10.39 percent in 1979 consumers only paid 1.6 points. But enough of those numbers, the important point is … why pay any points at all?

Clearly, consumers are paying less at the mortgage pump. Point-wise. Why? I've got a good guess … because rarely does paying points, or origination fees for that matter, make good financial sense. At least in getting a return from the points paid. And more importantly, consumers might just be finding out that paying points is an option and not a requirement.

A discount point, at 1 percent of the loan amount, usually benefits the borrower by .25 percent. For each point paid, the borrowers rate is reduced by .25 percent. At least that's the way it should generally work. Some consumers get screwed right out of the gate by paying 2 or 3 points just because their loan officer told them they had to.

For instance, on a standard 30 year fixed rate today at 6.50 percent with a $300,000 loan the payment would be $1,896. At no points. Now pay one point and get a .25 percent lower rate at 6.25 percent and the monthly payment drops to $1,847, or $48 lower. But that lower payment costs $3,000. Tax deductible usually, but still $3,000.

If you divide that $3,000 by the $48 monthly savings it would take 62.5 months to "recover" that discount point paid at purchase. That's a long time in my book. One could take that $3,000 and put it into a retirement fund or something and get a better return. Or even take the $3,000 and make a principal pay-down with that same money.

But often the trade-off between discount points and lower payments rarely makes sense. For that matter, so does paying an origination fee. An origination fee is also typically 1 percent of the loan amount and is also an option and not a requirement.

Every loan that I know of doesn't automatically require you to pay an origination charge. Heck, in certain parts of the country origination fees are mostly unheard of. In certain parts of the country where origination charges aren't common the rates are the same there as they are anywhere else.

This means that when getting a rate quote or deciding whether or not to pay points or origination charges, think hard. Points and origination fees don't have to be a part of the equation. They can, and should be, a choice.

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