Points on a mortgage loan can be one of the most confusing aspects of financing your home. The process of taking out a mortgage is intimidating enough…throw in unfamiliar jargon and fees and you’ve got a recipe for financial nightmares. Points on a mortgage loan come in two flavors and depending on the lender and your financial situation you may or may not be required to pay both types. Here are several tips to help you make sense of points and decide paying points is right for you.
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What Are Mortgage Points?
Points come in two varieties: there are discount points you pay to your lender and origination points you pay to the mortgage broker arranging your loan. Regardless of the type of point, one point is always equal to one percent of your mortgage amount.
What Are Origination Points?
The first variety of “points” you’re likely to encounter with your mortgage are origination points. This is a fee you pay to the Mortgage Company or broker for their part in “arranging” your loan. Origination points are not set by the lender and vary from one mortgage broker to the next. This fee is not the only form of compensation that your broker receives; mortgage brokers will also mark up your interest rate to get a commission from the wholesale lender. Because you’re already paying the mortgage broker a fee this markup is completely unnecessary and you should simply refuse to pay it. This unnecessary markup is called Yield Spread Premium and avoiding it is the topic of the free video tutorial available on this site. A reasonable fee to pay for mortgage origination is one percent of your loan amount and not a penny more.
What Are Discount Points?
Discount points are paid to your lender at closing in exchange for something. That something could be a lower mortgage interest rate, or is simply paid as a condition of qualifying for your loan. Your lender might require that you pay two points to qualify for a $150,000 mortgage; in this case you would be required to pay 2% of $150,000 or $3,000 at closing. If your lender does not require you to pay points you might consider paying points to lower your mortgage interest rate.
There are pros and cons to paying points to your lender in exchange for a lower mortgage rate. One disadvantage of paying this fee is that while it may lower your mortgage interest rate it does not lower your loan balance. You can generally expect that paying discount points will lower your mortgage rate by .25 percent for each point you pay. Remember that one point is one percent of your mortgage amount, due at closing. Whether or not it makes sense to pay discount points in your situation depends mainly on how long you plan on keeping the loan.
There are other advantages to paying discount points. The IRS considers discount points to be prepaid mortgage interest and you will be able to deduct part or all of your points depending on IRS rules for your situation. Before deciding if paying points makes sense you should determine how long it will take you to recoup the expenses based on the savings you’ll get from a lower mortgage payment. The longer you plan on keeping the loan the more sense it makes to pay points and recoup your expenses.
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