If you’re in the process of taking out a new mortgage to purchase your home or refinance an existing home loan you’re likely to encounter points before it’s done. Is it necessary or even beneficial to pay discount points on your next mortgage loan? Are mortgage points a bait and switch scam used to trick homeowners into overpriced mortgage loans? Here are several tips to help you avoid paying too much for your next home mortgage loan.
Discount Points Definition
Mortgage points come in two flavors. There are the discount points you can pay in order to buy down your mortgage rate and the origination points you pay the person arranging your home loan. They are very different fees and it’s important to understand how they work. One point, whether it discount or origination, is a fee that you’ll pay at closing and equals one percent of your mortgage loan amount. In the case of discount points you’re paying this fee in exchange for a lower mortgage rate. This is a legitimate fee that is often abused by dishonest advertisers trying to make their rates appear much lower than they really are. Points don’t always come in full percentages; you could pay less than one percent or more a point.
Suppose for instance you were going to pay one discount point to lower your mortgage rate from 6.0% to 5.75%. On a $250,000 mortgage one discount point would be $2,500 that you would pay at closing in exchange for this lower mortgage rate. The only situation where paying discount points make sense is if you plan on keeping your home for the long term. Even then, as low as mortgage rates are in today’s market the amount of time it will take you to recoup the expense of paying points may outweigh the benefit a slightly lower mortgage rate.
You can figure this out for yourself by spending a few minutes with a simple mortgage calculator. In the previous example your mortgage payment at 6.0% on a $250,000, 30 year fixed rate mortgage would be $1,498 per month. The same loan with a mortgage rate of 5.75% has a monthly payment of $1,458 per month. That’s a savings of $40 per month meaning it will take you 63 months, that’s just over five years to recoup your expenses before you realize any savings. Is it worth it? What happens if you refinance or sell your home before the five years are up? Your $2,500 is down the drain…
Are Mortgage Points Tax Deductable?
Because mortgage discount points are a form of prepaid interest, the points you pay at closing could be a tax deduction. Be careful when shopping for mortgage that your mortgage broker isn’t staring out with an inflated mortgage rate. If you’re a victim of this type of scam, you’re not paying discount points. Real discount points are paid to the lender, not the originator.
Other mortgage scams involving discount points come from companies advertising mortgage rates that seem too good to be true. If you come across one of these offers check the fine print and you’ll find that “x amount” of discount points are required at closing to qualify. Always ask if paying discount points are required to qualify for the mortgage rate advertised.
What About Mortgage Origination Points?
Origination points are a fee paid to the person arranging your home loan. This “loan originator” could be a mortgage broker, company, or banker. Like discount points this is a fee you’ll pay at closing and one point equals one percent of your loan amount. How much is a reasonable fee to pay for mortgage origination? One percent is reasonable, provided the person arranging your home loan has not also marked up your mortgage rate to get a commission from the lender.
Many originators use a hidden commission known as Yield Spread Premium to boost their profits at your expense, often without telling or fully explaining what they’re doing. It’s not uncommon for shady mortgage brokers to charge you as much as two or three percent for loan origination in addition to inflating your mortgage rate for a bonus from the lender. Keep in mind that any markup of your mortgage rate by the broker drives up your monthly payment unnecessarily. Want to avoid overpaying for your next mortgage loan? Learn how to recognize and avoid the markup of your interest rate for Yield Spread Premium.
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I was brought on to be a programmer for a mortgage company, so I broke out some old closing statements for research and was shocked to see a charge for over $3,800. But, it wasn't in the debit column, it had it's own column on the closing sheet, very confusing. Simply glossed over it. There is so much paperwork at the closing, even when you're told, you don't see the YSP.