My wife and I have recently applied and been pre-approved for our first mortgage. We are moving to a new state this winter. We applied for a 30-year fixed rate loan from one of the big national banks that have survived and actually flourished during the current credit crisis and subprime mortgage mess. We were offered a great interest rate thanks to our good credit and hefty sized down payment, but the rate still included an origination fee. Many people do not realize that even in today’s rough economy, you can negotiate your interest rates that are proposed to you by the bank.
Is Your Origination Fee Part Of Your Interest Rates?
An origination fee, which is usually 1% of the loan amount, is an upfront fee charged by the lender for administrative costs of processing a loan. Part of the bank’s profit is also wrapped up into the origination fee. Many people think that the fee covers charges like the appraisal, application fee, and credit report costs, but these costs are separately listed in most closing cost estimates instead. So, the fee is more profit than anything. This is your interst rates that we are talking about here, and it will pay you handsomely down the road to focus on these details.
When Do You Pay Your Origination Fee?
I have written before about the pros and cons to paying points and origination fees. My wife and I do not plan on living in our house for longer than five years. My job requires our family to move around a lot. Origination fees are pretty much a necessity in home loans. You can either pay the cost up front in the form of a point (1% of the loan amount) or you can spread the cost over the life of the loan. Paying the point lowers your rate interest rates, but spreading the origination fee over the term of the loan raises your annual percentage rate (APR).
Usually, if you will be in your home a long time, it will save you money in the long run to pay the fee up front. But, if you plan to only live in your home for a few years, like me, it may be cheaper to pay a little more every month with a higher APR. For example, for a $250,000 mortgage you might expect to receive a loan for 6% if you pay the origination fee or 6.25% if you wrap the fee into the loan. Your monthly payments would be approximately $1,528 paying the fee or $1,570 Wrapping it into the life of the loan. You can see a great breakeven analysis of when to pay points and not at this blog posting.
That $50 difference every month actually adds up to a lot of money over a 30 year home mortgage. By not paying the $2,500 (1% of the sales price) at the time you bought the house, you would pay over $18,000 in extra interest over 30 years ($50 x 30 years x 12 months). In this example, you need to own your home for approximately four and a half years before you would breakeven paying the 1% at closing.
So, I called our mortgage banker that my wife and I are working with at the big national bank. I told her that I loved the mortgage that we were getting but that the 1% fee was giving me heartburn. I did not want to pay it because I would not be in the home long enough to recoup it. The banker then told me that my APR would raise by 0.375%, but luckily I had done my research. A local credit union that I am eligible to join only raises its your interst rates by 0.25% for wrapping the origination fee into the loan. Armed with this knowledge, I was able to negotiate a reduced rate on our mortgage. I represented a savings of $20 a month, $240 a year, and $7,200 over the life of the 30 year note. Not bad for five minutes worth of research before calling the bank.