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.
My name is Rob Regehr and I’m a personal finance writer with a chip on my shoulder for banks and brokers that take advantage of my friends and neighbors.
