What are mortgage points and why would I pay them?
A point is one percent of the total amount of a mortgage. Mortgage points come in two varieties: origination points and discount points.
Mortgage origination points are a fee paid to compensate the lender (or broker) for the effort of evaluating and processing the loan and charged most often to people who do not have very good credit. Some say its to offset the risk while others argue its because these clients will pay anything to buy a home.
Discount points work a little different and are used to reduce the interest rate. You can usually “buy” as many points as you want on a loan, from a quarter of a point, all the way up to four or five points which in turn lowers you interest rate. A good formula to use is paying one point often equals around a 0.25% lower mortgage rate and whether or not you should buy points will depend on your unique financial situation and goals.
If you are in a situation where you can afford to pay a lot of money up front and plan to stay in your new house for a long time you may want to consider paying discount points. However, if you could barely scrape together a down payment for the mortgage, but expect your financial situation to improve over time, going without points is probably the best bet. The length of time you plan to stay in your home is a big factor as it can take years to recover the cost of points and if you are someone who moves every few years buying points can be a terrible waste of money.
Do I have to pay points at closing?
Sometimes people do not have the money to pay for points at the time of closing, but choose to “roll them into the loan.” By doing this, they are adding the cost of the points to the balance of the loan, but getting the lower interest rate. This may seem counter-productive, but again, it can make good financial sense if you plan to be in the house you are financing for a long time.
How much can points lower an interest rate?
A single point lowers the interest rate between one eighth and one quarter of one percent. Therefore, you would essentially be paying one percent of the loan up front to save an eighth or a quarter of a percent on interest over the whole life of the loan.
For example, if you have a $100,000 loan at five percent interest, you could by two discount points at $1,000 each for a total point cost of $2,000. This could lower the interest rate to as low as 4.5%. With this rate change, it would take just about five years to make back the money you spent on points through interest savings, so it would be a good move for someone planning to stay in the house longer than five years.
Are points tax deductible?
Origination points are usually not tax deductible because they usually include fees that would normally be itemized, like notary fees and inspection fees. If, however, the origination points were charged just for the purpose of getting the mortgage itself, they may be deductible.
Discount points are tax deductible in the year in which they are charged. This is another important consideration in deciding whether to pay points. If you need some extra tax saving in the year, in which you buy the house, discount points can help a little with that.
How else can I get a lower mortgage rate?
The first key to getting a lower mortgage rate is to get control of your credit rating. The better credit rating you have, the better interest rate in which you will qualify. You can check your credit rating through one of the major credit bureaus and then take the necessary steps to build or repair your credit in preparation of getting a loan.
It’s always a good idea to check and see if there are any federal loan programs you qualify for. VA loans, FHA loans, and other federal programs can sometimes get you a reduced rate or lower down payment. Sometimes a professional organization or employer may be able to land you a better rate, as well.
Shopping around is always a good idea for finding a good mortgage rate. Beyond your own bank or credit union, it’s a good idea to shop online and even use loan comparison sites to find the best rates. When shopping online, though, be careful to check to be sure that the company offering the loan is legitimate as there are many scams out there.
To get the best possible interest rate, you should try to finance the mortgage for the lowest number of years you can afford. The downside of cutting the years off your mortgage is that it increases the monthly payment, but the interest rate could be as much as a full percentage point lower. Usually your choices are 15 or 30-year mortgages, but many lenders also offer 10, 20 or 25-year mortgage options.
Adjustable rate mortgages are also sometimes a good option to save money on interest. The introductory rate generally lasts from five to seven years and could be as much as a full percentage point lower than the fixed rate for a loan. The danger of this type of loan is that it adjusts to a new rate after the introductory period is up, and it could be considerably higher than the starting rate.
You have many options for obtaining a mortgage. Understanding how the different types work will ensure that you can keep your home for years to come.
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