How to Refinance a Mortgage

Points are one of the most misunderstood aspects of mortgage loans. In the simplest definition mortgage points are a percentage of your loan amount due at closing for one of two possible reasons. Here are the basics you need to know about mortgage points and how you can decide if paying them is worthwhile when refinancing your home mortgage loan.

Types of Mortgage Points

Mortgage points come in two flavors. One point is equal to one percent of your mortgage amount and is the fee you’ll be required to pay at closing. There are the discount points you pay to the lender in exchange for a lower mortgage rate and the origination points you pay to the broker for their part in arranging your loan. Brokers and lenders do not always require that points be paid; however, some lenders hide their point requirements in the fine print hoping to distract you with an unnaturally low mortgage rate.

If you don’t agree to pay the points required for that low mortgage rate you’ll find the actual interest rate is often much higher than the going market rate. This is a common bait and switch tactic used by mortgage lenders to boost their profits. Fortunately once you understand how points work this is an easy scam to avoid.

Should You Pay Mortgage Points?

Deciding whether or not paying points to the lender is in your best interest depends on how long it will take you to recoup the expense based on the lower monthly payment you are getting. We’ve all seen the commercials on television promising insanely low rates with a lot of very small print flashed up on your screen. If you pause the commercial and squint you can just make out that this lender requires two points at closing to qualify for this low rate. Does it make sense to pay the fee?

You can easily determine this with a simple mortgage payment calculator. First compare the lower payment with points to the higher payment without points. The difference between the two payments is your monthly savings. Suppose you were refinancing a $200,000 loan with this lender. Two points would amount to $2,000 due at closing. If the monthly payment is $35 lower it will take you almost five years to recoup this expense. If you plan on staying in your home for the long term paying points can be beneficial; however, if you sell your home before this you’ll be losing money by paying points.

What About Origination Points?

Mortgage brokers often charge origination points for their part in arranging your loan. Not every mortgage charges origination points as brokers can receive compensation from the lender behind your loan. If your broker is charging you a fee for arranging your loan a reasonable fee to pay is 1-1.5% of your loan amount. You can learn more about your mortgage refinancing options including costly mistakes to avoid by registering for my free video tutorial.

If you are in the process of purchasing your home or refinancing your existing mortgage you will most likely encounter the term “points.” What are points and is it ever in your best interest to fork over additional cash at closing? Here are the basics you need to understand about mortgage points and whether or not it’s in your best interest to pay them.

Mortgage Points Come In Two Flavors

There are two varieties of mortgage points. The first are the origination points you pay for your loan originators part in arranging your loan. Your loan originator could be a mortgage company, internet mortgage site, your bank, or a mortgage broker. Origination fees vary widely and are one of the reasons many homeowners overpay for their mortgage loans. How much is a reasonable amount to pay for your mortgage origination points? A reasonable fee to pay is one percent of your loan amount and not a penny more.

One Mortgage Point = One Percent of Your Loan Amount

The second type of mortgage points you will encounter are the “discount” points you pay in exchange for something from the lender, usually a lower mortgage rate. Discount points can be used for other reasons when negotiating; for example you could negotiate to pay discount points in exchange for a certain rate and not having a prepayment penalty included in your loan contract. Don’t underestimate your ability to negotiate with mortgage lenders, especially with the current economy. Mortgage lenders are hurting and are desperate to close loans. You can leverage this to your advantage when negotiating for loan terms.

Should You Pay Discount Points?

The decision to pay discount points depends on your financial situation and what you have to gain by paying this fee. One of the main factors to consider is how long it will take you to recoup the expense from paying discount points with the lower mortgage payment. You can easily calculate how long this will take by dividing the amount you’ll pay in discount points by how much lower your mortgage payment will be because of the fee. This will tell you the number of months it will take you to recoup paying discount fees before you realize any savings. If you plan on selling your house within the next five years or in the amount of time you calculated above, it doesn’t make sense to pay discount points.

There Are Tax Advantages When Paying Discount Points

Paying discount points will earn you a tax deduction in most cases. According to the IRS the discount points you pay are prepaid mortgage interest. There are stipulations and you may or may not be able to deduct the full amount in one year according to IRS rules; however, this prepaid interest can certainly reduce your tax liability if you itemize deductions on your tax returns.