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Why Mortgage Lenders Are Requiring Upfront Points

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There’s been a recent phenomenon where mortgage lenders are requiring borrowers to pay upfront points when obtaining a home loan.

This runs counter to the typical experience where you can easily acquire a no cost home loan with no points or closing costs required.

As to why this is happening, it’s basically because the mortgage market has been so volatile lately.

Simply put, it’s difficult to determine the value of a mortgage loan because it’s unclear where mortgage rates go next.

To mitigate that unknown, many lenders are charging points to ensure some profits are being captured upfront.

Why Do Mortgage Lenders Charge Points?

Mortgage lenders charge points to collect profit upfront as opposed to over time via regular monthly interest payments.

Or to offer lower-than-market interest rates to entice mortgage rate shoppers to go with them instead of someone else.

This money is obtained from the borrower via a loan origination fee or via discount points, the latter being a form of prepaid interest.

Instead of waiting to collect interest each month once the loan is closed, they can collect some money upfront.

In exchange, you should get a lower mortgage rate versus the borrower who doesn’t pay points.

Collecting more now means less has to be paid later (via a higher interest rate) to account for the unknown, such as prepayment.

Of course, many lenders sell their loans to investors shortly after closing, but the same principle applies.

If you opt to pay little or nothing at closing, the lender’s investor will expect a mortgage with a higher rate so they can earn more interest over time.

Either way, you’re paying something, it’s just how you pay. At closing via points or during the loan term via a higher mortgage rate.

How Will Recent Mortgages Perform?

Because mortgage rates have more than doubled in a year’s time, there’s a lot of uncertainty regarding recently-originated home loans.

Will borrowers who got mortgages in 2022 keep them for the long haul, or will they quickly refinance them if/when mortgage rates improve?

Sure, mortgage rates could fall this year, but it wouldn’t be improbable for them to move even higher.

The big worry for lenders and mortgage investors is a scenario where rates improve enough for many of these borrowers to refinance.

A recent stat from Black Knight found that 10% of 2022 mortgages would become refinance candidates if the 30-year fixed fell to 4.75%.

If these homeowners refinance, their loans no longer earn investors interest. So whatever was paid for the loan above its par value would be lost.

In normal times, lenders can sell their loans to investors at a premium, and use the proceeds to cover their commissions and your closing costs (via lender credits).

Currently, this is proving difficult because the value of these loans is shaky at best. This is why profit is being taken upfront.

When mortgage rates are stable, this isn’t as much of an issue. It also wasn’t a problem when the Fed was indiscriminately buying mortgage-backed securities (MBS) by the boatload via Quantitative Easing (QE).

Paying something upfront also ensures that the interest rate you receive isn’t sky-high to account for that lack of upfront profit and/or an absence of closing costs.

In other words, lenders can make mortgage rates appear more attractive (lower) by requiring you to pay something upfront.

Pay Close Attention to Mortgage Rate and Fee Combinations

As noted, the current mortgage rate environment is disjointed and volatile. This has made it difficult for investors to determine the value of the underlying loans.

This is why you may see multiple mortgage points tacked onto advertised mortgage rates.

In normal times, you might see “no fees, no points” loans advertised more frequently. Or perhaps loans that only require a single mortgage point be paid.

Today, it could be two points upfront AND closing costs paid out of pocket. That can get expensive, especially if you’ve got a big loan amount.

This volatility also means there’s more spread between mortgage companies. So you really need to pay attention to mortgage rate and fee combinations.

And take more time to shop around with different banks, lenders, mortgage brokers, etc.

In short, rates and fees can vary tremendously between lenders right now, so shop accordingly.

Upfront Costs May Drop Before Mortgage Rates Do

In the past month or so, mortgage rates have come down and stabilized a bit.

The 30-year fixed, which had surpassed 7% and looked to be heading toward 8%, is now averaging closer to 6.5%, per Freddie Mac.

If you’re willing to pay upfront points and closing costs, the rates can be even lower, perhaps in the mid- or even low-5% range. That’s not too bad historically.

If you’ve been shopping mortgage rates for a while already, you may have been unimpressed by the downward movement.

But if you pay close attention, you might notice that lenders are requiring less in the points/fees department, even if the underlying mortgage rate isn’t significantly lower.

In other words, the loan has gotten cheaper to obtain, even if the interest rate isn’t vastly better.

This brings up a good point – when comparing mortgages, you need to look at the big picture. This includes both the interest rate and fees, commonly known as the mortgage APR.

If you don’t, you might not get an apples-to-apples comparison.

Should You Pay Points on Your Mortgage Right Now?

$400,000 Loan AmountPaying 2 Points ($8,000)
No Cost Loan
Mortgage Rate5.25%5.875%
Other Closing Costs$2,000$0
Total Upfront Cost$10,000$0
Monthly P&I Payment$2,208.81$2,366.15
Monthly Savings$157.34

When shopping for a mortgage, the question of whether to pay points is always pertinent.

But right now it might be even more important than ever, seeing that we could be at a crossroads.

Will mortgage rates go up or down in 2023? No one knows, but there are arguments to be made on both sides.

If you decide to pay a bunch upfront to lock in a slightly lower rate, you might kick yourself if the 30-year fixed trickles down to the mid-4% range during the year.

At that point, you’d probably be forced to refinance to take advantage of the lower rate, and effectively lose what you paid upfront.

Conversely, if mortgage rates remain elevated, or even more higher, you’d look smart with your lower mortgage rate, even if it’ll take some years to recoup the cost.

In my example above, it would take more than four years to break even on those upfront costs.

Of course, most forecasts are calling for lower rates throughout the year, and a possible recession. And mortgage rates tend to fall during recessions.

So the smart money is probably saying don’t pay points right now because you might be able to exchange your high-rate mortgage for one with a lower rate in the near future.

You may also be able to go for a cheaper adjustable-rate mortgage until things settle down, or take advantage of a temporary mortgage buydown.

Regardless, put in the time to compare rates/fees with multiple companies to ensure you don’t overpay on either front.

Those who invest time upfront might be able to get a decent rate without a ton of fees.

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