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Getting Familiar with Mortgage Points

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Real Estate

Getting Familiar with Mortgage Points

Getting a mortgage is tough, so being up-to-date with the lingo and all aspects of mortgages is certainly a plus. One aspect you should certainly be familiar with is mortgage points. To learn more about this term and how you will use it during your mortgage hunt, please read our information below.

What Is a Mortgage Point?

A mortgage point are fees paid directly to the lender at closing in exchange for a reduced interest rate.  This is also called “buying down the rate,” which lowers your monthly mortgage payments. So, if a mortgage lender tells you he will charge you one mortgage point, it means they will charge 1% of the overall mortgage and reduce your interest rate by a certain percentage.

Let’s put this phenomenon in numbers, so you can easily understand it. If you obtain a loan of $200,000, it means that a mortgage point will cost $2,000. If your mortgage lender says he will charge two mortgage points, it means a cost of $4,000.

Interest rate deductions implemented by mortgage lenders can vary greatly. They depend heavily on the mortgage amount too, so mortgage points can be different for various borrowers. Also, you may pay more for a mortgage point on a higher loan, the mortgage lender can charge multiple points for smaller loans. Therefore, don’t be fooled to believe that a smaller loan is not subject to mortgage points.

Break Even Point

An important thing to consider is how long will it take recoup the cost of the points.  Each month you will save a little bit and when the cumulative amount of those savings equal the points you paid, that is called the break-even period.

In the example above, you’ll see that if you paid $2,000 for one point to lower your interest rate 0.25%, you’d have a monthly payment savings of $30.55. To find the break-even point, you’d divide $2,000 (the upfront cost) by $30.55 (the monthly savings), to see how long you’d have to live in your home for it to be worth the upfront cost. In this example, it would take 65.4 months to recoup the initial cost.  So if you were planning on staying more than 5.5 years, it would be wise to pay mortgage points.

Bankrate provides a unique mortgage rate calculator

Are There Different Types of Mortgage Points?

There are different types of mortgage points; this includes points charged by the mortgage broker or bank or mortgage points you decide to pay as the borrower.

The first type of mortgage point – provided by the broker or bank – is also known under the name loan origination fee. Please note: this is a separate fee from lender costs and commission.

Borrowers can get an option to pay mortgage discount points. These types of points are used as a prepaid interest at closing and can be used in exchange for a lower interest rate. So, if you want a lower rate than what the mortgage broker is offering, then you might benefit from the mortgage discount points.

Please note that some mortgage points can be deducted on your tax return; this certainly applies to the loan origination fee (the mortgage points charged by the broker or bank). However, certain conditions apply, so check with the IRS before you decide to add a loan origination fee to your tax return.

Conclusion

Opposed to what many people believe, mortgage points are not only used as a fee for the brokers and or bank. By using the second type of mortgage points (prepayment), you can effectively reduce your interest rate and get a mortgage that is a lot more interesting in the long run. If you don’t know what your mortgage point options are with your current lender or broker, then it might be worth shopping around a bit for a mortgage. Compare available lenders and find the one that provides you the best mortgage point advantages. Of course, you must still consider the other aspects of your loan before making a decision.

 

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