Many people have heard of the word points or have heard of the term, paying points, as it applies to buying a home. Some consumers, however, are not sure what that word or term means, and this is unfortunate because the subject is important. This article examines the basics behind the point system in home buyer.
When you buy a home, you must often pay points. Paying points is a method of paying interest in one lump sum, up front, in order to get a lower interest rate on a fixed rate mortgage. It is easy to calculate the value of a singe point. One point is equal to 1% of the mortgage amount. It is easy to see that the more points you pay, the lower your mortgage rate will be.
An example might be: A 30-year, $150,000 mortgage might have a rate of 6.7%, but come with a charge of 1 point, or $1,500. To pay this point, you would have to pay the $1,500.
A lender can charge 1, 2 or more points. There are two kinds of points: Discount points and origination points.
Discount points: These types of points are truly prepaid interest on the mortgage loan. The more points you pay, the lower the interest rate on the loan. It also goes that the fewer points you pay, the higher the interest rate will be. Home buyers will normally try to pay anywhere from 0 to 4 points, depending on how much cash they have on hand and how much they want to lower their interest rates. This type of point is currently tax-deductible.
Origination Points: This is also known as an origination fee with some lenders. It is charged by the lender to pay for the costs of making the loan. The origination point (or fee) is deductible only if it was used to get the mortgage and not to pay other closing costs. For the most current rules on this you should check with your lender, attorney, or the IRS.
When deciding how many discount points to pay, home buyers should consider the following. Keep in mind that the more points you can pay now, the lower your monthly payment will be. Here are some issues to consider:
How much cash can you spend on points, and do you have this cash on hand?
How long do you expect to have the home or the mortgage? The key here is that the longer you intend to have the mortgage or the home, the more sense it makes to pay as many points as possible up front.
If you intend to keep the home for a long period of time, it may be worth reducing the interest rate by paying more points. On the other hand, if you require the lowest possible closing costs, choosing a 0 point or slightly higher point value may be your best option.
You can find online calculators that can help you see the differences that points can make with any particular loan. You simply input the information that you have such as the amount of the loan, the length of the loan, interest rate, and points paid and the calculator will show you the results. This is a good way to get fast information on points and how they can affect your loan in the long run.
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