Mortgage points are one of the most misunderstood concepts in the mortgage world. On the surface, points are scary, and many consumers equate points with mortgage scams and unnecessary junk fees. However, nothing could be further from the truth.
If utilized correctly, points can be used to save you thousands of dollars through properly structuring your mortgage. So, first of all, what are points?
One point is equivalent to 1% of the loan amount. So, if you are obtaining a $300,000 mortgage, one point equals $3000. Points come in two categories, origination and discount points. Although both origination and discount points are technically the same thing, origination points are typically a fee that a mortgage company charges to do your loan where as discount points are points used to discount the mortgage or lower your rate.
The 5 Myths:
So now that you understand the basics of what mortgage points are, here are the 5 most common myths about mortgage points.
1. Points are a fee that goes to the lender. Technically, this is correct. Points do go to the broker, however, an honest broker will help you obtain a lower interest rate if you choose to pay points.
2. Points must be charged on every transaction. Not true. Brokers get paid two ways- through points and/or through "yield spread premium" or a percentage paid to them directly from the lender. If the broker charges points, the yield spread premium will be zero or negative, and if the broker does not charge points, he or she will make a percentage from the lender for their services. Here is an example:
"No Points" Loan Program: 30 year fixed Loan Amount: $200,000 Rate: 6.375% Points: 0 Cost of points: $0 Monthly payment: $1247.74
"One Point" Loan Program: 30 year fixed Loan Amount: $200,000 Rate: 6.0% Points: 1 Cost of points: $2000 Monthly Payment: $1199.10
Points should always be your choice. In this scenario, you would save $48.64 per month in the form of a lower payment by paying an up front point cost of $2000. Carefully consider whether you will be in the home long enough to recover the cost of the points before making this decision.
3. Points are tax deductible. This is partially true. When you purchase a home, points are tax deductible in their entirety in the year you purchase the home. In a refinance transaction, you must "amortize" the cost of the points over the term of the loan. In other words, if you have a 30 year loan, in the case of a refinance, you can only write off 1/30th of the cost of the points each year for 30 years.
4. Points are paid up front. Many consumer mistakenly think that mortgage points must be paid out of pocket before their transaction closes. This is not true. Points are charged at closing as part of the settlement charges.
5. Points can be used to buy down the rate as low as you want to go. Points are used to obtain a lower interest rate, however, some clients have asked me if they can pay, for example, 5 points to lower their rate to an extremely low rate. Unfortunately, this cannot be accomplished for two reasons.
First of all, predatory lending laws prohibit a broker's total fees to exceed a certain percentage of the loan amount. Second, there is always a threshold with every loan program where the lender makes it unattractive to continue to buy down the rate. In other words, perhaps you can "buy down" the rate .375% for each of the first two points. The lender will likely make it unattractive to use additional points, only allowing you to better your rate by .125% for each additional point beyond 2 points. This is because there is an ebb and flow of money in the economy, and mortgage paper at an unusually low rate is not as hot of a commodity for lenders to have in their portfolio.
I hope that you now feel more comfortable with the concept of mortgage points. It is critical that you find an honest mortgage broker who is looking out for your best interests and can give you an analysis of the long term effects of different loan structures based on your unique situation. With hundreds of loan programs available in the marketplace, it is only through careful consideration of your needs and long term financial goals that the right decision can be made.
RJ Baxter has been a mortgage consultant for 4 years and has consistently ranked in the top ten among over 400 mortgage consultants in his company. RJ has also received several awards for customer service and loan volume throughout his career.
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