In the world of mortgage loans, you may have come across the term ‘points.’ But what exactly are points and how do they affect your loan? In this blog post, we will dive into the details of points and help you understand their significance in the mortgage lending process.
What are Points?
Points, also known as discount points, are fees that borrowers can pay to a lender at closing to reduce the interest rate on their mortgage loan. Each point is equal to 1% of the total loan amount. For example, if you have a $200,000 loan and pay one point, it would cost you $2,000.
By paying points, borrowers can lower their interest rate and, ultimately, reduce their monthly mortgage payments. The more points you pay, the lower your interest rate will be. This can result in substantial savings over the life of your loan.
Types of Points
There are two types of points: origination points and discount points. Origination points are fees charged by the lender to cover the cost of processing the loan. These points are typically negotiable and can vary from lender to lender. On the other hand, discount points are used to buy down the interest rate.
While origination points are often a fixed percentage of the loan amount, discount points can be customized based on the borrower’s preference. It’s important to note that each discount point typically lowers the interest rate by a certain percentage, such as 0.25% or 0.5%.
When Should You Pay Points?
The decision of whether to pay points or not depends on your personal financial situation and how long you plan to stay in the home. Paying points can be advantageous if you plan to stay in the home for a long time. The upfront cost of the points can be recouped over time through lower monthly payments.
However, if you’re planning to sell the property or refinance in the near future, paying points may not be beneficial. It’s important to calculate the break-even point, which is the number of months it will take to recover the cost of the points through the monthly savings. If you don’t plan to stay in the home beyond the break-even point, it may be more cost-effective to opt for a higher interest rate without points.
The Tax Implications
It’s worth mentioning that in some cases, points may be tax-deductible. If you itemize deductions on your tax return, you may be able to deduct the points paid in the year you purchased or refinanced your home. However, it’s advisable to consult with a tax professional to understand the specific tax implications in your situation.
Points play a significant role in the mortgage loan process, allowing borrowers to lower their interest rates and save money in the long run. Understanding the different types of points and when it makes sense to pay them can help you make an informed decision when securing a mortgage. Remember to carefully consider your financial goals and consult with a reputable lender or mortgage advisor to determine the best approach for your individual circumstances.