Now, before we go further, it is essential that you thoroughly understand the two concepts we've covered so far: “points” are a means of calculating fees and an “origination” fee is the lender’s commission. Reread everything up to this point if you must, but do not proceed until those two concepts are crystal clear in your mind; otherwise the information in this blog will be useless to you.
Now that you've grasped the principles of cost of service versus cost of money, you must learn to distinguish the two from each other. I’ll illustrate with the following example: Assume you wish to borrow $300,000 for the purchase of a home. Let’s further assume that ’you've settled on a thirty-year loan at a ﬁxed rate of 4.375% per year. If the loan is fully amortized (meaning it will be completely paid off at the end of its term), your monthly payment will be $1,497, most of which is interest, especially during the early years of the loan. In fact, after twelve months you will have paid $13,026 in interest, but your principle balance will have been reduced by only $4,948 Furthermore, if you keep the home for ﬁve years and make all the payments as per your contract, you will have paid and astounding $62,823 in interest, yet your loan balance will still be $281,224. In other words, after only one-sixth of the loan term has passed, the amount you have paid in interest alone is already equal to more than 20% of what you originally borrowed. Yet, you still owe almost ninety-ﬁve percent of the original loan amount and you have another twenty-ﬁve years to go before it is paid off. But wait! That is only the cost of the money. You still haven’t paid for the service of having the lender provide it for you. And if you agreed to an origination fee of only two tiny little points, you will have paid an additional $6,000 at the close of the loan, before you've even made your ﬁrst payment, and we haven’t even covered all the other fees yet. When presented in this context, does two “points” seem like a reasonable commission? The answer depends upon how much service you desire, or require, and what other providers are willing to accept in exchange for rendering the same service.
Here is where I want to remind you of a very important point: Caveat Emptor applies only to people. Finding an honest, ethical loan ofﬁcer is much more important than haggling back and forth over “points” in an attempt to reach an arbitrary ﬁgure that you deem acceptable; because, as I will demonstrate further in, there are other, much less obvious ways that a loan ofﬁcer can fatten his paycheck at your expense, without increasing the amount or quality of service you receive. (For more on the meaning of the term “service” see the chapter Negotiating The Origination Fee.)
Now, I know there are some of you out there thinking that you've already got this one ﬁgured out. The simple solution: a no points loan! But why stop there? Why not go all the way and choose a no cost loan? They certainly do exist. We hear them advertised all the time. Well, for those of you who have not yet begun to absorb the theme of this book, I’ll pose another question. Do you think no points means no commission?
“Why not?” I hear you shouting. “They can take it out of all the interest they’re going to charge me!”
That certainly would seem reasonable, if the lender were indeed going to keep all that interest. Yes, you read it right. The company that originally makes the loan to you is not going to beneﬁt from receiving one dime of interest over the life of the loan, even if you choose a so-called “direct” lender; because nearly all of them will sell the residential loans they make within days of closing.
“But I've been making my payment to the same company for years!” You say.
No matter, the loan has more than likely been sold, and your lender has merely retained the right to collect the monthly payments and administer the loan on behalf of an investor who is the real owner of the mortgage. Furthermore, most lenders will not even make a loan in the ﬁrst place unless they already have an investor waiting to purchase it. For those of you who thought there was some advantage to using a “direct” lender, all I can say is I’m sorry—there is no such thing as a direct lender, unless you are getting a loan from a private individual.
I will explain how all this works in the next chapter. For now, just remember that unless your lender collects his proﬁt at the close of the loan, he will have worked for nothing. Therefore, you will always pay a commission and other service fees at closing. Your only choice is that of the form in which they are paid (i.e., visible, or invisible). It will be your responsibility to determine what you are paying and whether or not the cost is reasonable. Here’s a rule to help you decide on a fair price for services rendered: Service can be good, fast, or cheap; but the best you can do is two out of three. You choose which two you want, the one leftover will be their price.
Read Next: 4. What is the Secondary Mortgage Market - The Money Behind the Mortgage Money >
< Read Previous: 2. What are Mortgage Points - Breaking Out of the Borrower's Knowledge "Bubble"