Monday, 19 November 2018
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The Definitive Guide to Understanding Mortgage Points

Written by Posted On Sunday, 04 November 2018 20:04

Let's be real here. Buying a home is a huge decision both emotionally and financially. In fact, a recent study found that people ranked buying a home to be more stressful than divorce, bankruptcy, and even the death of a loved one! In other words, it's vital that you feel equipped and ready to tackle this milestone before you're knee-deep in real estate chaos.

If you’re in the process of buying a home, you may have come across the term mortgage points. Commonly known as discount or origination points, these refer to fees paid directly to the lender at the time of closing in exchange for a decreased interest rate. In essence, this can help lower your monthly mortgage payments.

Origination points compensate loan officers. The fee is often negotiable and contingent on the mortgage provider. Discount points refer to prepaid interest, where the purchase of each point can lower your interest rate to by up to 0.25%. Depending on your financial situation and your lender, you can typically purchase between 1-3 points.

How Discount Points Work

The premise of discount points is relatively straightforward (check it out here). One point costs 1% of your mortgage amount (or $1000 per every $100,000). You pay the upfront interest for a lower interest rate over the total lifespan of your loan.

If you plan to own your home for a long time, this plan can help you save on the total interest during the entire lifespan of the mortgage loan. In general, the longer you plan to stay in the home, the more you can save if you purchase discount points.

Furthermore, you'll ideally reduce the number of monthly payments you need to make to the lender. That provides you with significant savings in both the short and long-term. If you become successful in getting the return on your investment of mortgage points, you will enjoy a reduction of your total house costs.

Are Mortgage Points Right For You? 

Just like with any significant financial crossroads, it’s critical to run the numbers before making your decision. You want to ensure that you’ll generate a break-even period. To figure this sum out, divide the total cost of points by the total savings of your monthly payment. This number will show you how long it will take for the monthly payment to equal the cost of the points.

If you plan on leaving your home before reaching this break-even period (or you're not sure if you will), you may want to rethink mortgage points. 

Other Mortgage Point Considerations

There are a few other key factors to consider when determining mortgage points. 

Tax Benefits

The IRS tends to reward home ownership. By investing in real estate, you can enjoy numerous tax deductions and participate in various relief programs.

With that in mind, buying points may provide you with a tax benefit. You should consult with your CPA to determine if this will positively impact your tax situation. However, the amount you paid for discounted points is typically deducted from the income taxes amortized throughout your refinanced period.

PMI Concerns

If you find yourself faced with the decision between making a 20% down payment and buying mortgage points, run the numbers and screen your financial portfolio. A lower down payment may mean you have to carry private mortgage insurance (PMI), and this cost could negate the benfits associated with buying points.

While PMI isn't inherently a bad thing, especially if you need to own a home quickly (and you have every intention of paying your mortgage every month, paying for additional points would be counterproductive to your financial plan.

Interest Rates

Just like most things in life, not all lenders are created equal. Not all interest and points work on the same playing field. Furthermore, the interest rate reduction for buying points isn’t set automatically. It will depend on the individual lender and the marketplace. Make sure that you do your research to understand the terms and conditions for your particular lender.

 

Are Mortgage Points Right For You?

 

As mentioned, there are a few factors you need to consider. One, you want to make sure that you have enough cash available upfront. In addition to the down payment and additional closing costs and insurance associated with your home, purchasing mortgage points will cost you more than if you didn't use the points.

 

Furthermore, you should consider how long you intend to stay in the home. While nobody can read the future, you should have a general idea regarding whether this is a potential ‘forever’ home or more of a temporary arrangement (such as relocating for a job or planning to move if you have more children). If you're not sure whether you will stay past the break-even period, this could be a dealbreaker. You may risk spending more money on the upfront costs than you would if you didn't take the points.

The bottom line is this: purchasing a home represents a tremendous financial decision that you shouldn’t take lightly. Plan accordingly and carefully and run the numbers. Before you even begin your search process, determine the monthly mortgage you can comfortably afford and determine how you will get and afford that payment.

Shop around. Talk with different lenders. Discuss your ideas with real estate agents and brokers. Ask questions. Buying a home can be stressful, but you can be smart with your decision! Don't be afraid to look for different and creative ways to save money. It's worth the peace of mind.

 

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