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Mortgage Points Explained
Taket the time to understand mortgage points and you can save a bundle on your mortgage over the course of your loan.
It's no surprise that mortgage points are often not fully understood by buyers. After saving up for a down payment and adding in closing costs and other fees, shelling out a few more thousand dollars for points doesn't seem worth it. At that point in the house-buying process, most buyers just want to finish the transaction and aren't motivated to educate themselves on points.
So, is the expense worth it? Unfortunately, the answer is "maybe"! If you plan to be in your house for any length of time, though, the answer is a bit clearer.
What is a mortgage point?
Mortgage points actually refer to two different things: loan origination fees and discount points. Most of the time, though, discount points are what people talk about when they refer to mortgage points. Discount points refer to the amount of money that a person pays to a lender to get a loan at a specific rate. These points are basically like pre-paying interest on the loan.
Why would you want to purchase points?
A person simply pays for mortgage points on a loan in order to get a lower mortgage rate. A mortgage point is not the same thing as a percentage point off of your mortgage rate. Instead, it is equal to 1% of your loan. For example, if you have a $300,000 loan, a point would be equal to $3,000. It depends on your lender, but in general, each point will take off about 1/4 to 1/8 of a percent off of your interest rate.
Points are tax deductible.
Because points are interest-payment related, they are fully deductible on your taxes in the year that you close. For a refinance, the deduction still exists, but must be spread out over the duration of your loan.
Are they a good idea?
Before you can even consider whether or not purchasing points is a good idea, you have to make sure that you will have the extra cash at closing as you pay for the points up front. Points are not a fee that you can finance.
If you have the money on hand, you should also consider how you might otherwise invest it. If you can get a return greater than the money that you will save on your loan, then you are better off investing you money elsewhere.
On the surface, it might seem like an obvious choice: pay points and lower your mortgage rate. However, you really have to do an analysis to figure out if the expense is worth it and how long it will take to break even.
Generally speaking, it takes about five to seven years to recoup the cost of paying for a point. There are many excellent online calculators that can help you to figure out the details for your specific situation.
Mortgage points can add up to valuable savings over the course of your loan. Make sure that you understand them before you become so entrenched in the details of closing your mortgage that you don't have the bandwidth to consider them!
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