Points: When are they OK?
When a loan agent starts talking about a “loan origination fee” or “points,” a signal may go off in the borrower’s head alerting her to a problem. These two things (which are the same thing) have been recently ingrained in many of us to represent a red flag, and for a very good reason.
Loan agents can make money through a few channels: They can charge arbitrary fees that sound official (e.g., approval fee, application fee, etc.), they can charge fees that actually are sane (see my article on brokerage fees), and they can make money from the lender providing the money on the loan, based on the chosen interest rate. You might get an agent, however, who will charge you a loan origination fee in a legitimate manner.
Consider the purchase of a home. In the real estate world, you might hear the terms “buyer’s market” and “seller’s market.” In a buyer’s market, houses are not “flying off the shelves,” as it were, so sellers have to give buyers incentives to buy their houses. A seller’s market is the opposite, but we’re only really concerned with a buyer’s market in this example.
For a purchase in a buyer’s market, a seller might give the borrower a “seller credit” towards the non-recurring closing costs (e.g., lender fees, title fees, documentary transfer taxes, etc.). This credit is perfectly legal and can be extremely useful when determining buying power, if you have a trustworthy loan agent. Let’s look at an example:
We’ll assume the purchase price of a house is $350,000, that the buyer is going to put down $70,000 at closing (giving a $280,000 loan amount), and that the seller is going to credit the buyer $10,000 for closing costs, since the house has been on the market for a while now and he is worried about getting it sold. The closing costs for the loan come out to about $8,500. Since the buyer has a $10,000 credit towards those closing costs, she now has $1,500 left over.
Here’s the catch, though: if you do not use the entire credit at the close of the loan (i.e., when you’ve signed the documents and have been given the loan), the unused amount goes away. This is because lenders do not want cash going back and forth between the buyer and seller directly. It behooves you to use as much of the credit as you have been given. But if the closing costs only come out to $8,500, how do you spend the rest?
The answer is by allowing the loan agent to charge a loan origination fee. This fee will be charged to the credited closing costs, costing you absolutely nothing. What this allows the loan agent to do, then, is not rely as heavily on the money he receives from the lender at the close of the loan, which means he can ultimately drop your interest rate (since his “rebate” and your interest rate are tied). If the loan agent would have given you 6.500% knowing he would have made $1,500 from that, he may be able to instead give you 6.250% and not make anything from the rebate, but instead make his money through the seller’s credit.
A word of caution, however, as always: A loan agent is not obligated to do this, and a bad one might even absorb the rest of the seller’s credit and charge you a loan origination fee on top of that (and when the seller’s credit is used up, it’s coming out of your pocket) and make an exorbitant amount of money from the lender as well, while keeping your interest rate as high as he wants it to be.
A seller credit can be a great tool for easing your way into your first home purchase, or any purchase in a buyer’s market. Make use of it, but watch your loan agent carefully. If the seller’s credit has been suspiciously used up and you still owe more money than seems necessary at closing, you might want to look into a second opinion.