Back points, or yield spread premiums as they are more formally called, are commission points paid to the loan originator that are hidden from the borrower. You have heard advertisements that say that if you refinance your current loan, your payment will decrease, your loan amount will not increase, and not a penny will come out of your pocket. Common sense tells you that the company offering the loan has to be making money somehow.
Example: Assume that you have a current interest rate of 8%. Your payment on a thirty-year loan is $1,467.53. Also, assume that the best current interest rate you could get is 6%. The company offering the loan is simply a mortgage broker placing the loan with a lender for a fee. If the lender can get a high enough interest rate, the lender is willing to pay the fee. If you get a loan at 6.5%, the lender is getting a.5% premium. On a $200,000 loan, this costs approximately an extra $1,000 per year. The lender is willing to pay the broker offering you the loan a point (1%) for placing the loan. The broker gets $2,000, and you get a monthly payment of $1,264.14, with no money out-of-pocket.
Because the lender is subsidizing your payment of the point, the loan may contain a clause saying that if you pay it off before a certain time, you will have to pay a penalty. This will give the lender back the subsidy if you do not pay on the higher rate long enough to make up the back point paid on your behalf.
If you are using a mortgage broker for a loan with no points, ask what the broker will receive from the lender and how it will affect your loan. If the loan has no points or fees, and the broker says that there are no back points, find a more truthful broker. You know the broker has to be paid by someone. Some questions to ask the broker include the following.
• What is the difference in the interest rate between the no points loan and a loan with one or two points?
• How long must I pay on the loan with points before I break even?
• Is there a prepayment penalty on the no points loan, and if so, what is the amount or formula used to determine the amount?