Fees and Expenses in Obtaining a Home Loan
You know that there's no thing as a free lunch. In order to get a loan for your home, there are certain expenses that must be paid:
- There are expenses to get a loan: closing costs.
- There are expenses in using the money over time: interest rate plus discount points, plus PMI.
You pay to get the money (closing costs which includes the origination fee, appraisal fee, title insurance, etc.). You pay to use the money (interest rate + discount points).
While just about everyone understands the interest rate they will pay in exchange for obtaining a loan, many people are confused about some of the other costs, including points, origination fees, and PMI, or Private Mortgage Insurance.
What are "Closing Costs"?
Closing costs are the non-reoccurring costs associated with purchasing or refinancing real estate. It's the sum of fees paid to the mortgage company, the attorney, the title company, the appraiser, the credit bureau, and others in order to help you get the loan.
These fees can be reduced by increasing the interest rate, in which case the lender pays some of the closing costs now for increased revenue later.
What are Points?
We have loans with zero points. A "point" is used in the mortgage industry to mean one percentage point of the loan amount. One point = 1% of the loan. For a $100,000 loan, one point is $1,000.
You may choose to buy a lower interest rate by paying extra cash at the real estate closing. One point when used to discount (lower) the interest rate, is called a "discount point". Usually paying one-half of a discount point will lower the rate by 0.125%.
Discount points can sometimes be financed in the loan amount.
You may also choose to lower your closing costs by choosing a higher rate, and we will pay you. This payment to you is used to help pay some of closing costs.
- To get a lower rate, you pay a little more cash at closing (discount points). This can usually be financed in the loan.
- To get lower closing costs, you choose a slightly higher rate.
What is an Origination Fee?
An origination fee is paid to the mortgage company for helping to arrange financing, and getting you approved. The origination fee is not related to discount points, however the numbers are in the same format.
For example, a loan origination fee of 1% is equal in dollars to one discount point which is also 1% of the loan amount. They are not related in any other way.
What is PMI?
It is an insurance policy to protect the lender in case of loan default. Is is not life insurance or credit life insurance.
Do I have to buy it? Private Mortgage Insurance is usually required by the lender when the first mortgage is greater than 80% of the value of the property (or sales price).
PMI is for the benefit of the lender. If the property is abandoned or goes into foreclosure, this policy protects some of the value of the home. It is not life insurance.
This policy is usually required if the loan-to-value (LTV) ratio of the first mortgage is greater than 80%. However, there are exceptions. There are loans for 100% of the purchase price that do not require PMI, and some loans at 75% LTV that require PMI.