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Points Versus Fees

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Posted On: 03/30/2016

Question:

We want to buy a house and have been looking at loan choices from different lenders. They all seem to require an origination fee. One lender says it will waive the 1 percent loan origination fee if we will accept a .25 percent rate increase. Should we go for the higher rate?

Answer:

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A loan origination fee is a charge paid to the lender at closing for the service of creating the mortgage.

A loan origination fee is a charge paid to the lender at closing for the service of creating the mortgage.

Let’s run some numbers. Let’s say that the lender charges a 1 percent loan origination fee. If you borrow $150,000 you will pay a $1,500 origination at closing.

Going forward, if there is a 4 percent fixed interest rate, your monthly cost for principal and interest on a 30-year loan is $716.12.

If you elect not to pay the origination fee, then the interest rate will rise to 4.25 percent. As a result, the monthly cost for principal and interest will increase to $737.91, an extra $21.79 a month. Divide $1,500 by $21.79 and here’s the bottom line: it will take 69 months before your monthly cash costs start to exceed the original $1,500 out-of-pocket fee.

According to Freddie Mac, the typical loan is now outstanding for seven years; that’s 84 months. If it happens that you pay $21.29 for an additional 15 months (84 months minus 69 months) the extra expense with the higher interest rate amounts to $319.35.

Having looked at some numbers you can now see your choices with greater clarity.

It’s likely cheaper to pay the loan origination fee up front.

But, paying $1,500 in cash at closing may not be comfortable if your funds are limited.

Both the mortgage interest and the loan origination fee are likely to be tax deductable, but there may be exceptions and complexities.

For example, according to the IRS “the term ‘points’ is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points also may be called loan origination fees, maximum loan charges, loan discount or discount points.”

Such costs are generally deductible for a home purchase; there can be different rules with a refinance. Other factors may also apply, so be sure to talk to a tax professional for guidance.

Remember, be attentive to conditions in your local real estate market. By any chance does the owner feel an urgency to sell? If so, you may be able to negotiate the sale agreement and have the seller pay some or all of your points.

If you can get the owner to pay the loan origination fee then you save cash at closing plus you get the lower rate, the best of both worlds.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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