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Wednesday, March 24, 2010

What you need to know about mortgage points.

Homebuyers looking to finance the purchase of a home with a mortgage have no doubt run into the term, "points." Just what are points, what do they do and how can they help? Read on for more information.

Discount points are fees/pre-paid interest paid to a lender at closing to buy down the interest rate on a mortgage for a home for a certain amount -- the more points you pay, the lower your interest rate. Each point will cost you 1 percent of the loan amount and may be able to lower your interest rate by at least .25% (one quarter of a percentage point). So, if you are borrowing $100,000, a point will cost you $1,000. If you are borrowing $300,000, a point will cost you $3,000.

The other kind of "points" are "origination points" that lenders will charge you to cover the costs of the loan. When a borrower considers purchasing additional points, they are discount points -- the ones that can buy down an interest rate.

Pros of discount points
If you expect to stay in a home for a long period of time (e.g., at least three to five years), discount points will save you money in the long run, since they reduce your interest rate and lower your monthly payment for the life of the loan.

Paying a little more for your loan at closing in discount points will help lower your monthly mortgage payments. For example, if you have a $300,000 mortgage for 30 years at a 6% fixed rate, your monthly payment would be just under $1,799. But if you purchased one point (at a cost of $3,000), you may be able to lower your interest rate to 5.75%, meaning a monthly payment of about $1,751 -- a savings of $48 a month. It varies how much a lender will reduce an interest rate for a point. (E.g., from one-eighth to one-quarter of a percentage point.)

Discount points are deductible from your taxes and you can get them deducted in the same year as your home purchase. (They usually are deducted under Schedule "A" of your IRS 1040 tax return.)

Cons of discount points
You will need more cash at closing to purchase your home. If you need to keep your closing costs as low as possible, you may want to consider not purchasing additional points.

You must stay in the home for a number of years before the points pay for themselves. For that $300,000 loan we talked about above, it would take nearly 63 months (or more than five years) to earn back the $3,000 you paid in points. So if you were to move before the five years, you would have wasted your money on the points.

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  1. Good Morning,
    To pay/or not pay discount points? One thing to keep in mind, the example given of paying a 1pt. discount fee to reduce ones rate from 6.00% to 5.75% and thus your monthly payment by $48, one also needs to calculate the return on your investment ($3000), by dividing your cost by the payment reduction of $48 you will find it takes just over 5 years to breakeven (3000 divide by 48= 62.5 months) so if one is going to know for a fact they will stay in the home for at least this long, then yes it may be a wise investment, but you had better not refinance or sell prior to this. One idea I am usually in favor of is when the seller is providing the cost of this buy down through seller contributions, then in most cases I would be a strong advocate of looking into this. My clients will know the best way to maximize their hard earned money. My team and I work hard with The Cascade Team to ensure this.
    Frank Hinkley, Mortgage Consultant.
    Guild Mortgage Company

  2. I'm glad Frank mentioned what I call the "breakeven point" for buying down the rate. It's absolutely a requirement to do this calculation or you could be wasting your money.

  3. Interesting post here...The article mentions the break-even point in the 'Cons of Discount Points' at the end that supports what Frank is saying.

    Having come from the mortgage world, there is really only one product I would ever advocate 'paying discount' points on for most everyone and it's not on any of the traditional products out there (i.e. 30yr fixed or 5-7yr ARM).

    I say most everyone because as Frank eludes to but doesn't quite say, 'most' people are not in the habit of thinking of that upfront cost as an 'investment' that they are willing to 'ride out' long enough to truly realize the benefit. He and the article states 3-5 years but when I talk to clients I double that number because in order to truly realize the benefit of the 'investment' of those initial funds, you have to keep it longer than it takes to break-even. If you only rode it out to break-even, it's just as much a waste as if you left or refinanced early.

    Real estate for most people is not an investment, it is simply a purchase that they more likely are going into knowing that they will not be there for the long term because of any number of outside influences that create 'life-changing' adjustments (i.e. job, addition to the family, divorce, death etc) These types of adjustments typically happen every 5-7 years for most people; this also happens to be the definition of long-term for most people.

    Most people simply don't get the real benefit of paying that kind of upfront cost because of the kind of life-styles we've adapted to of moving every 3-5 years. You can take that $3k and put it into another investment and double your money in the same period of time. I tell people if you've got that kind of scratch laying around then put it towards something else and 'diversify' your portfolio.

    If someone is offering it as an incentive, I would say ask to lower the price of the home instead which means that money stays in your pocket that can then be used for other investment opportunities.

    Only if you have disposable income and are already well invested or if you're really up against the wall and looking to get into a home where the monthly payment would help should this be considered. Given how the latter worked out in the last real estate boom, I would never advocate it but instead tell the client they need to lower their price-point.

    Frank has a healthy (income wise) clientele list and is very good at navigating his clients through this type of option and never has a 'one fits all approach'.