Fed study shows how much discount points are driving up costs

Discount points have driven mortgage borrowers' out-of-pocket costs up 33% in the past few years, a Federal Reserve study finds. 

Home buyers last year paid on average around $6,500 at closing, compared to $4,900 in 2021, according to The Federal Reserve Bank of Philadelphia. The bank's Consumer Financial Institute in a new research paper analyzed public data and also found nonbank transactions more expensive for consumers compared to depositories, credit unions, fintechs and home builders. 

The paper's authors said use of discount points overall jumped from around 0 in 2021 amid ultra-low rates, to 0.7 points on average last year. Close to a third of home loans had over one point in 2023, up from about 10% in 2021. Over 10% of loans last year included 2 or more points, and points were more common in independent mortgage bank originations. 

"This heterogeneity suggests rising points may be related to supply-side factors (e.g., differences across lenders in the costs of mortgage lending) more so than demand-side factors (i.e., borrowers wanting to buy down their rate)," the paper's authors wrote.

The findings coincide with recent data from Optimal Blue showing increased points on transactions through September, the paper cited. The Mortgage Bankers Association's Weekly Applications Survey for early November also showed points for various products rising. 

Fed researchers looked at Home Mortgage Disclosure Act data, including nonpublic information regarding credit scores, and application and closing dates. The study only focused on 30-year fixed-rate conventional and Federal Housing Administration-backed first-lien purchase originations for single-family, owner-occupied loans. 

The findings are also limited by HMDA's "borrower-paid" data, as authors note undetermined concessions by sellers and home builders. The study also assumed one point as 1% of the loan amount, usually resulting in a 20 to 25 basis point interest rate reduction.

Net points and fees, or origination charges minus lender credits, more than doubled between 2021 and 2023, from $1,500 to nearly $3,500, the Fed found. The rise was driven by discount points, while lender fees themselves averaged over $1,000 during the time period. 

Average third-party costs, such as appraisal and title fees, also remained largely unchanged from the end of 2021 through 2023, at $3,000. All of those recent costs combined for the near-$6,500 in out-of-pocket costs for borrowers last year. 

Nonbank-originated home loans last year had rates 11 basis points higher than banks, and 20 basis points higher than credit unions, the report said. Regarding points, nonbanks charged 0.21 points more than banks. Credit unions meanwhile charged 0.24 points less than banks last year. 

"Combining these results, and assuming that a 25 bps rate buydown corresponds to one point, suggests that nonbanks typically charged about $2,000 more than banks, and $3,750 more than credit unions, in 2023 for a $300,000 mortgage," the paper said. 

Homebuilders had average interest rates 70 basis points cheaper than banks, and charged 0.8 points more than banks on average. Fintechs had pricing comparable to banks, with interest rates about 9 to 10 basis points lower than depositories, offset by 0.21 to 0.26 more points on average between 2021 and 2023. Such digital startups have rolled out competitive, unique offers to attract first-time homebuyers. 

Regarding today's homebuying environment, the authors suggested lender credits were less common with still-elevated mortgage rates. Authors emphasized the limitations of HMDA data, and said the rate benefit with paying points wasn't clear across lenders.

"The increase in points implies that the simple headline rise in mortgage rates understates the true rise in mortgage costs," the authors wrote. "If points had not risen, rates likely would have climbed to even higher levels than they did."