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Mortgage Points

DEFINITION

Mortgage points are a common real estate practice in the United States. They are also called discount points and are basically fees that a borrower pays a creditor directly at closing in exchange for a lowered interest rate on their mortgage payment.

EXPLANATION

There are two different kinds of mortgage points. The first is discount points, which are

equivalent to 1% of a totally mortgage amount due per point. Basically, homeowners are paying part of their mortgage up front in order to pay less on a monthly basis over the course of paying off their property. Each point usually lowers the interest rate on a mortgage up to .25%.

The second variety is origination points. These points go directly to lending officers as an administrative fee. Not every loan will need the borrower to repay origination points. Those lenders that do will usually be willing to negotiate.

When considering paying mortgage points it’s important to think about how long it’ll take to regain the value from having bought points, or when the break-even period will be in effect. This is calculated through dividing the expense of the monthly payment against the money save on interest. The result will tell prospective buyers the length of time it will take before they break even.

When determining whether buying mortgage points is the right way to go, there are some things to think about. Firstly, since it will have an upfront cost, buyers should make sure they have all of the costs immediately available, including reserves, a down payment and closing costs. It makes more sense selecting a mortgage with a fixed rate. How long a buyer plans to own the property is also important; if the plan is to own it long term then mortgage point may make sense. In some cases, mortgage points can be a great choice, but it’s important to understand how they work.

An example of the way discount point is the following: Let’s say a homeowner has $200,000 mortgage and their interest rate is at 4%. This means that their monthly mortgage payment would cost about $995 per month. With one discount point purchase, or paying $2,000 on the spot, the interest rate that they have to pay the lender would drop down by about 3.75%. This means that their monthly payment would go down by about $29 on a monthly basis.

Factors About Mortgage Points

–              Tax benefits may be a result of buying mortgage point depending on the specific circumstances. Origination points on a home loan are tax deductible as of 2017, but only up to the first $750,000. The standard rate that goes with the tax deduction is higher, so it’s important to do the calculations.

–              Even though the point of buying mortgage points is to offset interest costs, the lower interest is not fixed or guaranteed to last. The rate will change with fluctuations in the market, as well as the lender.

–              Adjustable rate mortgages, or ARMs, only have a fixed rate for a pre-specified period of time, which means that mortgage points will only apply for so long. The point of breaking even should a significant time before the rate of the mortgage adjusts.

–              When choosing between whether to pay the 20% down payment on a home or whether to buy mortgage points, if a prospective homeowner decides to make a down payment then it might mean that they will have to purchase private mortgage insurance, or PMI. If this offsets the benefit of purchasing mortgage points the it may be necessary to consider.

Qualifications for Tax Benefits

When a homeowner prepays on interest, it’s likely that the payment will be tax deductible. That said, there are eligibility requirements set out by the IRS:

–              The area in which the property exists has to accept discount points as a business practice.

–              Discount points only apply to a buyer’s main residence.

–              The amount of the discount point payment is similar to typical costs in the area of purchase

–              The year the discount points are received must be recorded and the payment must be deducted the year they are paid.

–              Discount points count only toward the purchase, and can’t be used in exchange for legal, property, title, or other fees.

–              The loan has to be taken out and used for the acquisition or building of a home.

–              Discount points are expressed as a percent of the total loan amount.

–              The Closing Disclosure has to have the amount paid clearly shown as charged discount points.

Other Considerations

There are arguments that there are better ways to use the funds that would go to discount points. The stock market could be a good place to invest and receive a higher return. For most average buyers, the future potential to make a higher return is less important than making sure the ability to sustain an ongoing mortgage is there.

Even if a property gains value, it’s likely property in the surrounding areas will gain value to a similar extent. If this becomes the case, the homeowner will be saddled with the task of purchasing a new residence a bit above the selling price of their home. The reality is also that if a homeowner takes the standard 30 years to pay off their home it’s very likely by the time the mortgage is paid, the money invested with be almost triple the amount of the original cost of purchase.

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