What are mortgage points ⁠— and how do they work?

What Are Mortgage Points and How Do They Work?

What are mortgage points ⁠— and how do they work?

Mortgage points are kind of free throws in a basketball game. And points are how you win the game, so you want as many as you can get, right? Turns out, these points come at a cost. And it’s not always worth it.

Mortgage points can be super confusing, which makes it really hard to know whether or not they’re a smart choice for you. Are they really a money-saving deal?

Since buying a home is one of the most expensive purchases you might ever make, we’ve found out everything you ever wanted to know about mortgage points. (Lucky for you, we’ve narrowed it down to what’s actually important.)

Types of Mortgage Points

So what types of points are we playing for here? Just with basketball (stick with us here), there are different types of mortgage points: origination points and discount points.

Let’s get origination points the way (because, honestly, that’s not really what this article is about). This type of mortgage point is basically a fee that doesn’t lower your interest rate. It just pays your loan originator. Trust us, you’re better off paying out-of-pocket for their service. Skip origination points.

Dave Ramsey recommends one mortgage company. This one!

Next up (and for the rest of this article), let’s talk discount points. Lenders offer mortgage discount points as a way to lower your interest rate when you take out a mortgage loan. The price you pay for points directly impacts the total interest of the loan. And the more points you pay, the lower the interest rate goes.

That might sound all sunshine and roses at first, but get this—it’s going down because you’re prepaying the interest. In reality, you’re just paying part of it at the beginning instead of paying it over the life of the loan.

How Do Mortgage Points Work?

After you apply for a mortgage, your lender will offer discount points as a way to lower your overall interest rate. Your point options will be on official home transaction documents the Loan Estimate and Closing Disclosure. Most lenders allow you to purchase between one to three discount points.

To buy mortgage points, you pay your lender a one-time fee as part of your closing costs.

How Much Does One Point Lower Your Interest Rate?

One discount point usually equals 1% of your total loan amount and lowers the interest rate of your mortgage around one-eighth to one-quarter of a percent. But heads up: the actual percentage change will depend on your mortgage lender.

Is your head spinning yet? Well hang on, we’re about to do some math.

To help this all make sense, let’s break it down. Suppose you’re buying a $300,000 house. You have a 20% down payment and are taking out a 30-year fixed-rate conventional loan of $240,000 at a 4.5% interest rate.

To lower the interest rate, you pay your lender for one mortgage point at closing, and assuming that point equals 1% of your loan amount, it will cost $2,400.

$240,000 loan amount x 1% = $2,400 mortgage point payment

After you buy the mortgage point, your lender reduces the interest rate of your mortgage by, say, a quarter of a percent. That takes your interest rate from 4.5% to 4.25%.

This slightly lowers your monthly payment from $1,562 to $1,526—which is $36 less a month on a fixed-rate conventional mortgage.

You can use our mortgage calculator to figure the difference between the interest amount with the original rate (4.5%) and the interest amount with the reduced rate (4.25%) over the full lifespan of the loan.

Are you still with us? Okay, good.

Without any mortgage points, you’ll pay a total of $197,778 in interest. With one mortgage point, you’ll drop that amount to $185,035—which saves you $12,743 in total interest.

$197,778 original total interest paid – $185,035 reduced total interest paid = $12,743 amount saved

But when you account for the $2,400 you paid for the mortgage point, you really only saved $10,343.

$12,743 interest savings – $2,400 mortgage point = $10,343 true savings

Okay, we know we just threw a lot of numbers at you hard and fast. Just know this process is known as “buying down the rate.” But remember, you’re really just prepaying interest here. The more points you buy, the more interest you prepay—which is why your lender would be willing to lower the interest rate on your loan (they’re not Santa Claus after all).

Take a look at the chart below to see how this example plays out with two mortgage points.

30-year loan amount: $240,000No Points1 Mortgage Point2 Mortgage Points
Cost of Point(s)N/A$2,400$4,800
Interest Rate4.5%4.25%4%
Monthly Payment$1,562$1,526$1,491
Monthly SavingsN/A$36$71
Total Interest Paid$197,778$185,984$172,486

Should You Pay for Mortgage Points?

It seems odd to say, but buying mortgage points to lower your interest rate could actually be a complete rip off. Say what? How can a lower interest rate be a bad deal?

For starters, it could be years before you really save any money on interest because of your mortgage points. To see what this would look , you’d first need to calculate what’s known as your break-even point.

What Is the Break-Even Point on a Mortgage?

The break-even point is when the interest you saved is equal to the amount you paid for mortgage points. They sort of cancel each other out.

Alright, it’s time to go back to math class again. Let’s calculate the break-even point from our example we used before. To do this, just divide the cost of the mortgage point ($2,400) by the amount you’d be saving per month ($36). And there you have it, that answer is the break-even point.

$2,400 / $36 = 67 months (5 years and 7 months)

In other words, in 67 months, you’d have saved over $2,400 in interest—the same amount you paid for the mortgage point. After reaching the break-even point, you’ll pocket that $36 each month, which will be the money you save on interest because of the mortgage point you bought.

Are Mortgage Points Worth It?

Here’s the thing: Mortgage points could be worth it if you actually reach your break-even point—but that doesn’t always happen.

According to the National Association of Realtors’ 2018 report, the median number of years a seller remained in their home was 10, the same as last year. From 1985 to 2008, NAR reports the tenure in a home was six years or less.(1)

While 10 years is enough time to break-even in our example, most buyers won’t regain their money on mortgage points because they usually refinance, pay off, or sell their homes before they reach their break-even point.

While 10 years is enough time to break-even in our example, most buyers won’t regain their money on mortgage points because they usually refinance, pay off, or sell their homes before they reach their break-even point.

So what’s an eager homebuyer to do? Instead of buying mortgage points, put that extra money toward your down payment and reduce your loan amount altogether! Ding, ding!

An even better way to lower your interest rate without taking the risk of mortgage points at all is to shorten the length of your loan from a 30-year fixed-rate conventional loan to a 15-year one, which is the type we recommend.

If your estimated interest rate still looks way too high, get a real estate agent who can help you find a house that’s actually within your budget.

Beware of Adjustable-Rate Mortgage Points

If you’re thinking about getting an adjustable rate mortgage (ARM) loan, don’t do it! ARM loans are one of the top mortgages to avoid because they allow lenders to adjust the rate at any time. This just transfers the risk of rising interest rates (and monthly payments) to you—yeah, count us out. Seriously, these things are terrible.

Oh, and that’s not all. If you buy mortgage points on an ARM loan, lenders might only provide a discount on the interest rate during the initial fixed-rate period.

Once the fixed-rate period is over, you lose your discount, which could happen before you even reach the break-even period. How convenient! That’s a win for the bank—not for you.

Do Mortgage Points Affect Taxes?

Mortgage points may be tax deductible as home mortgage interest—but that still doesn’t make them worth buying. In order to qualify, the loan must meet a slew of qualifications on a lengthy list of bullet points, all of which are determined by the IRS.(2) 

If you’ve already bought mortgage points, check with a tax advisor to make sure you qualify to receive those tax benefits.

Get a Smart Mortgage

Let’s be real: Your house may be the biggest purchase you’ll ever make. Take the time to get this right! To find a good lender who can help you feel confident about your mortgage, contact our friends at Churchill Mortgage. They’ve helped thousands of people you understand and finance their home the smart way.

Источник: https://www.daveramsey.com/blog/what-are-mortgage-points

What Are Mortgage Points?

What are mortgage points ⁠— and how do they work?

Mortgage Q&A: “What are mortgage points?”

The mortgage process can be pretty stressful and hard to make sense of at times, what with all the crazy terminology and stacks of paperwork.

Further complicating matters is the fact that banks and lenders do things differently. Some charge so-called loan application fees while others ask that you pay points.  Then there are those that tack on lender fees and points.

While shopping for a home loan, you’ll ly hear the term “mortgage point” on more than one occasion.

– How Much Is a Mortgage Point
– How Do You Calculate Points on a Mortgage?
– There Are Two Types of Mortgage Points
– Paying Mortgage Points for a Lower Interest Rate
– How Do Negative Points Work on a Mortgage?
– Mortgage Point Examples
– Mortgage Points Cost Chart

Be sure to pay special attention to how many points are being charged (if any), as it will greatly affect the true cost of your loan.

How Much Is a Mortgage Point?

  • It’s just another way of saying 1% of the loan amount
  • So for a $100,000 loan one point equals $1,000
  • And for a $200,000 loan one point equals $2,000
  • The higher the loan amount, the more expensive a point becomes

Wondering how mortgage points are calculated? Don’t worry, it’s actually really easy. You don’t even need a mortgage calculator! Or a so-called mortgage points calculator, whatever that is…

When it comes down to it, a mortgage point is just a fancy way of saying a percentage point of the loan amount.

Essentially, when a mortgage broker or mortgage lender says they’re charging you one point, they simply mean 1% of your loan amount, whatever that might be.

How do you calculate points on a mortgage?

So if your loan amount is $400,000, one mortgage point would be equal to $4,000. If they decide to charge two points, the cost would be $8,000. And so on.

If your loan amount is $100,000, it’s simply $1,000 per point. It’s a really easy calculation. Just multiply the number of points (or fraction thereof) times the loan amount.

If it’s one point, take a calculator and input .01 multiplied by the loan amount. If it’s 1.5 points, input .015 multiplied by the loan amount.

Using $300,000 as the loan amount in the above equation, we’d come up with a cost of $3,000 and $4,500, respectively.

Assuming you’re being charged less than a point, we have to consider “basis points,” which are one one-hundredth of a percentage point (0.01%). Put another way, 100 basis points, or bps as they’re known, equals one percent.

For example, if you’re only being charged half a point, or 50 basis points, you’d calculate it by inputting 0.005 into a calculator and multiplying it by the loan amount.

Again, no basis points calculator needed here if you can manage basic math.

Using our loan amount of $100,000 example, a half point would equate to $500. If you were charged 25 basis points (0.25%), it’d be $250, and you’d calculate it by entering 0.0025.

Don’t get thrown off if the loan officer or lender uses basis points to describe what you’re being charged. It’s just a fancy way of saying a percentage of a point, and could actually be used to fool you.

As you can see, the cost of a mortgage point can vary greatly the loan amount, so not all points are created equal folks.

Tip: The larger your loan amount, the more expensive mortgage points become, so points may be more plentiful on smaller mortgages if they’re being used for commission.

There Are Two Types of Mortgage Points

  • The word “points” can be used to refer to two completely different things
  • Either the loan officer or mortgage broker’s commission for providing you with the loan
  • Or discount points, which are entirely optional and can lower your interest rate
  • Know what they’re actually charging you for to ensure you make the correct decision

There are two types of mortgage points you could be charged when obtaining a mortgage.

A mortgage broker or bank may charge mortgage points simply for originating your loan, known as the loan origination fee.  This fee may be in addition to other lender costs, or a lump sum that covers all of their costs and commission.

For example, you might be charged one mortgage point plus a loan application and processing fee, or simply charged two mortgage points and no other lender fees.

Additionally, you also have the choice to pay mortgage discount points, which are a form of prepaid interest paid at closing in exchange for a lower interest rate and cheaper monthly payments.

They are used to buy down your interest rate, assuming you want a lower rate than what is being offered. Generally, you should only pay these types of points if you plan to hold the loan long enough to recoup the upfront costs via the lower rate.

You can use a mortgage calculator to determine how many monthly mortgage payments it’ll take for buying points to make sense. This is essentially how long you need to keep the home loan to come out ahead.

Paying Mortgage Points for a Lower Interest Rate

  • It’s important to consider both the loan type your expected tenure
  • To determine if paying points upfront is a good deal
  • Generally worth looking into if you plan to stick with your mortgage/property for a long time
  • And if you want an even lower fixed rate you’ll actually benefit from for years to come

It would probably make more sense to pay mortgage points on a 30-year fixed as opposed to an adjustable-rate mortgage, seeing that you could benefit for many more months, though both situations could make sense depending on the price and associated discount.

Same goes for the homeowner who plans to stay in the property for years to come. Seeing that you’d save money each month via a lower housing payment, the more you stay the more you save.

Another plus is that these types of points are tax deductible, seeing that they are straight-up interest. And that tax benefit should be factored into the equation

*The loan origination fee may also be tax deductible if it’s expressed as a percentage of the loan amount and certain other IRS conditions are met.

If you aren’t being charged mortgage points directly (no cost refi), it doesn’t necessarily mean you’re getting a better deal.

All it means is that the mortgage broker or lender is charging you on the back-end of the deal. There is no free lunch.

In other words, the lender is simply offering you an interest rate that exceeds the par rate, or market rate you would typically qualify for.

So if your particular loan scenario had a par rate of say 4.25%, but the mortgage broker or bank could earn two mortgage points on the “back” if he/she convinced you to take a rate of 4.875%, that would be their yield-spread-premium (YSP), or commission.

Before this practice was outlawed, it was a common way for a broker to earn a commission without charging the borrower directly. Nowadays, brokers can still be compensated by lenders, but it works a bit differently.

They have to select a compensation package with each lender they work with beforehand so all borrowers are charged the same flat percentage rate.

Of course, they can still partner with three different wholesale banks and select varying compensation packages, then attempt to send borrowers to the one that pays the most. Yet another reason to be sure you negotiate!

Banks can offer mortgages without points as well because of the “service release premium” (their form of YSP), which is a fee they earn when they sell their loans to other companies on the secondary market.

Sure, you might not pay any mortgage points out-of-pocket, but you may pay the price by agreeing to a higher mortgage rate than necessary, which equates to a lot more interest paid throughout the life of the loan assuming you keep it for a while.

How do negative points work on a mortgage?

  • Some lenders may offer so-called negative points
  • Which is just another way of saying a lender credit
  • These points raise your interest rate instead of lowering it
  • But result in a credit that can cover closing costs so you don’t pay them out-of-pocket

If points are involved and you are offered a higher rate, the mortgage points act as a lender credit toward your closing costs. These are known as “negative points” because they actually raise your interest rate.

Now you might be wondering why on earth you would accept a higher rate than what you qualify for?

Well, the trade-off is that you don’t have to pay for your closing costs out-of-pocket. The money generated from the higher interest rate will cover those fees.

Of course, your monthly mortgage payment will be higher as a result. How much higher depends on the size of your loan amount and the points involved.

This works in the exact opposite way as traditional mortgage points in that you get a higher rate, but instead of paying for it, the lender gives you money to pay for your fees.

Both methods can work for a borrower in a given situation. The positive points are good for those looking to lower their mortgage rate even more, whereas the negative points are good for a homeowner short on cash who doesn’t want to spend it all at closing.

Let’s look at some examples of mortgage points in action:

Say you’ve got a $100,000 loan amount and you’re using a broker. If the broker is being paid two mortgage points from the lender at par to the borrower, it will show up as a $2,000 origination charge (line 801) and a $2,000 credit (line 802) on the HUD-1 settlement statement.

It is awash because you don’t pay the points, the lender does. However, a higher mortgage rate is built in as a result of that compensation to the broker.

Now let’s assume you’re just paying two points your own pocket to compensate the broker. It would simply show up as a $2,000 origination charge, with no credit or charge for points, since the rate itself doesn’t involve any points.

You may also see nothing in the way of points and instead an administration fee or similar vaguely named charge.

This could be the lender’s commission bundled up into one charge that covers things underwriting, processing, and so on.

It could represent a certain percentage of the loan amount, but have nothing to do with raising or lowering your rate.

Regardless of the number of mortgage points you’re ultimately charged, you’ll be able to see all the figures by reviewing the HUD-1 (lines 801-803), which details both loan origination fees and discount points and the total cost combined.

*These fees will now show up on the Loan Estimate (LE) and Closing Disclosure (CD) under the Loan Costs section.

Mortgage Points Cost Chart

Above is a handy little chart I made that displays the cost of mortgage points for different loans amounts, ranging from $100,000 to $1 million.

As you can see, a mortgage point is only equal to $1,000 at the $100,000 loan amount level. So you might be charged several points if you’ve got a smaller loan amount (they need to make money somehow).

At $1 million, you’re looking at $10,000 for just one mortgage point.  And you wonder why loan officers want to originate the largest loans possible…

Generally, it’s the same amount of work for a much bigger payday if they can get their hands on the super jumbo loans out there.

Be sure to compare the cost of the loan with and without mortgage points included, across different loan programs such as conventional offerings and FHA loans.

And remember that points can be paid out-of-pocket or priced into the interest rate of the loan.

Also note that not every bank and broker charges mortgage points, so if you take the time to shop around, you may be able to avoid points entirely while securing the lowest mortgage rate possible.

Read more: Are mortgage points worth paying?

Источник: https://www.thetruthaboutmortgage.com/mortgage-dictionary/mortgage-loan-points-mortgage-discount-points/

Mortgage Points: Are They Worth Paying?

What are mortgage points ⁠— and how do they work?

Editorial Note: Forbes may earn a commission on sales made from partner links on this page, but that doesn't affect our editors' opinions or evaluations.

Mortgage discount points are portions of a borrower’s mortgage interest that they elect to pay up front. By paying points up front, borrowers are able to lower their interest rate for the term of their loan. If you plan to stay in your home for at least 10 to 15 years, then buying mortgage points may be worthwhile.

What Are Mortgage Points?

Mortgage points represent a percentage of an underlying loan amount (one point equals 1% of the loan amount).

Mortgage points are an additional upfront cost when you close on your loan, but they’re also a way for borrowers to negotiate a lower interest rate on their mortgage.

For example, by paying upfront 1% of the total interest to be charged over the life of a loan, borrowers can typically unlock mortgage rates that are about 0.25% lower.

It’s important to understand that points do not constitute a larger down payment. Instead, borrowers “buy” points from a lender for the right to a lower rate for the life of their loan. Buying points does not help you build equity in a property—you just save money on interest.

There are two different types of mortgage points: origination points and discount points. Discount points represent prepaid interest that can be used to negotiate a lower interest rate for the term of a loan.

Origination points, on the other hand, are lender fees that are charged for closing on a loan. Origination points don’t save borrowers money on interest, although they can sometimes be rolled into the balance of a loan and paid off over time. Discount points, however, have to be paid up front.

How Discount Points Work

When you apply for a loan and get approved, your lender will give you a loan offer. In your offer, the lender will typically offer you multiple rates, including a base rate, as well as lower rates that you can get if you purchase discount points.

Those discount points represent interest that you’re repaying on your loan. If you decide to purchase points, you pay the lender a percentage of your loan amount at closing and, in exchange, you get a lower interest rate for the loan term. Typically, for every point you purchase, you get to lower your interest rate by 0.25%.

normal mortgage interest that you pay over the life of your loan, mortgage points are typically tax-deductible. However, points are usually only used for fixed-rate loans. They’re available for adjustable-rate mortgages (ARMs), but when you buy them, they only lower your rate for your intro period—several years or longer—until the rate adjusts.

When Paying Points Is Worth It

When you buy discount points, you decrease your monthly payment, but you increase the upfront cost of your loan. Due to the difference in monthly payments, it usually takes between five and 10 years to recoup the upfront cost of discount points.

Instead of buying points, many borrowers instead choose to make larger down payments (or make extra payments on their mortgages) in order to build equity in their homes quicker and pay off their mortgages early, another way to save money on interest payments.

Still, in some cases, buying points may be worthwhile, including when:

  • You need to lower your monthly interest cost to make a mortgage more affordable
  • Your credit score doesn’t qualify you for the lowest rates available
  • You have extra money to put down and want the upfront tax deduction
  • You plan to keep your home for a long time, so you may recoup the cost

Of course, this really only applies to discount points. Origination points, on the other hand, are closing costs paid to a lender in order to secure a loan. While these fees are sometimes negotiable, borrowers usually have no choice about whether to pay them in order to secure a loan.

Mortgage Points Example

Let’s say a prospective homeowner applies for a $400,000, 30-year mortgage so they can buy a $500,000 house. They have good credit and plenty of income, so they get approved. After underwriting, they get a loan offer from a lender that includes multiple rates—one with their rate if they purchase no points, plus alternative rates if they purchase one to four discount points.

Below are sample rates for this borrower, upfront costs to purchase those points and respective monthly payments for each rate:

In this case, each point would save the borrower about $60 per month. It would take a borrower 66 months (roughly 5.5 years) to recoup the cost of each discount point they purchase.

How to Negotiate Mortgage Points

When you apply for a loan, both discount points and origination points are theoretically negotiable. But, in practice, that’s not always the case. The only way to know for sure is to speak with your loan officer once you’ve been approved for a loan.

If you want to successfully negotiate either discount or origination points, one of the best things you can do is to apply for mortgages from multiple lenders. Then, when you get loan offers, you can let each lender work to earn your business by negotiating lower rates or closing costs.

You don’t need to worry about this hurting your credit score, as credit bureaus treat credit checks from multiple mortgage lenders within about a 30-day period as one credit check. They assume that you’re shopping around for the best rates, which you should do.

Deducting Mortgage Points on Your Income Taxes

When you purchase discount points (or “buy down your rate”) on a new mortgage, the cost of these points represent prepaid interest, so they can usually be deducted from your taxes just normal mortgage interest.

However, you can usually only deduct points paid on the first $750,000 borrowed. In other words, if you take out a $1 million mortgage and buy one point for $100,000, you can only deduct $75,000 (1% times $750,000). The extra expense—paid on the last $250,000—is not tax-deductible.

According to the IRS, the expenses for mortgage points can be itemized on Schedule A of your Form 1040. The IRS says that “if you can deduct all of the interest on your mortgage, you may be able to deduct all of the points paid on the mortgage.”

How Mortgage Points Affect Closing Costs

Mortgage points—both discount points and origination points—increase a borrower’s upfront cost of getting a mortgage. However, neither of these costs increases your equity in the property you’re borrowing against.

In the case of discount points, these costs are also optional. If you plan to stay in your home for at least 10 to 15 years and want to reduce the monthly cost of your mortgage, they may be worthwhile, but they aren’t required.

Источник: https://www.forbes.com/advisor/mortgages/mortgage-points-are-they-worth-paying/

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