SANTA CRUZ (April 11, 2009) - One of the most talked about and confusing aspects of a home loan is the loan origination fee.The loan origination fee is usually measured in points and represents a significant portion of the closing costs required when obtaining a mortgage. When it comes to mortgages, one point equals one percent of the loan amount. In order to obtain a $400,000 mortgage on a single family home or condominium, the combined title, escrow, appraisal and lender fees come to somewhere between $2500 - $3500. When adding in a typical loan origination fee of one point or, in this case, $4,000, the closing costs come to $6500 - $7500Technically, there are two types of loan fees that the borrower pays. One is called the loan origination fee and the other is the discount fee. Many times these are combined and simply referred to as points. The purpose of the points that the borrower must pay is two fold. One is to provide income for the lender (loan origination fee) and the other is to buy the interest rate down (discount fee).

In most cases, the more points a borrower is willing to spend, the lower the interest rate. When interest rates are quoted, they must be in conjunction with points. For example, if a 30 year fixed rate of 4.50 percent is quoted to a prospective borrower, there must also be a reference to the number of points that a borrower must pay in order to obtain that rate.

In years past, it was easy and expected for lenders to offer mortgages that did not include any points at all. This was possible because we were offered steep rebate pricing by the end investor. When this practice was so common, lenders were offered a one point rebate if their borrower was willing to accept a rate that was usually about one quarter of a percent higher than if they were willing to pay the loan origination fee of one point.

In the past with a $400,000 mortgage, a borrower would be able to choose between a 30 year fixed rate of 6.00 percent at a loan origination fee of one point or a 6.25 percent rate at no points. If you do the math here, you must keep your loan in place for at least 62 months to break even. The lender doesn’t care which you select because the income will be the same either way.

To take this one step further, by paying a rate of 6.5 percent, the lender could afford to pay all of the title, escrow and lender fees and still net the same income. This pricing practice ended up costing investors a lot of money because it created ‘churning’, which was the practice of obtaining a refinance and then, when rates dropped even just one quarter of a percent, the borrower would refinance again. Investors make money by keeping the loans on the books. If they payoff in short order, they lose money.

Investors and lenders have wizened up. Steep rebate pricing is no longer available. While it is possible to get no point loans, the borrower will usually have to pay dearly. For example, this week the cost of obtaining a no point loan was nearly a full one half of one percent in rate. A borrower would have to keep their loan in place for just 33 months in order to justify spending the one point to get a lower rate.

Like icing on the cake, points are deductible on your federal income tax. If it is a purchase of your owner occupied home, you may deduct the points in the year you incur the expense, even if the seller pays the points for you! If it is a refinance, the points are deducted over the life of the loan.

This column is written every Saturday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 of email him at Peter@SantaCruzHomeFinance.com.