What are mortgage points?
Decoding home mortgages is no cake walk. Nor catwalk. Nor boardwalk. It's more like a walk across a tightrope between two rickety spires. After all, like some performance artist in the midst of an act, every detail involves some form of tricky-to-maneuver trade-off.
The fees seem reasonable, but the API is off the charts.The API is lower than you had hoped for, but the underwriting fees add up to $8,000. And what on earth is this business about “mortgage points”?
Mortgage points might seem insignificant at first glance, but beware. Each itsy-bitsy point could slam unforeseen costs into your loan.
What are mortgage points?
To put things plainly, a mortgage point is a percentage point of the loan amount.
If a mortgage contract states that it will charge you two points, what it is really saying is that it will charge you 2% of your overall loan.
In some cases, the funds denoted by the percentage point will go to a loan origination fee. The loan original fee can cover all costs and commission, or be added to other lender costs.
How are mortgage points different from mortgage discount points?
The words are similar, but a mortgage discount point serves a different function.
Don’t be fooled: A mortgage discount point is not really a discount. On the surface, they bring down the interest rate. What they really mean is that you are paying for interest in advance.
Understand, mortgage discount points are not necessarily bad things. In certain circumstances, they can even be tax deductible.
However, when you are trying to compare two loan options for the same house apples-to-apples, overlooking the mortgage discount points involved can mislead you into thinking that you are getting a better deal on one of the options than you actually are.
On the other hand, mortgages with absolutely no mortgage discount points are more likely to funnel those costs into the rate.
Bankrate features a handy mortgage points calculator. If you already have a quote on hand (or, for that matter, are not the fastest with numbers) this resource is definitely worth checking out.
When Discount Points Are Good Things
It is conceivable that for some mortgages, discount points really will help you come out ahead, but it will generally take five or more years before the upfront interest payment provides an advantage.
Let’s tackle a sample scenario.
If you were to take out a 30 year fixed mortgage in the amount of $200,000 with 2 discount points at a rate of 5%, the monthly interest payment and principal would amount to $1,074.
An equivalent loan with no points at an interest rate of 5.5% would require a payment of $1,113. If you sell the house during your fifth year of home ownership, you will lose $81 compared to the points-free alternative. However, if you sell your house during the sixth year, you will be $702 dollars ahead for choosing the option with two discount points. By the 10th year of home ownership, the discount points will have saved $3,803. By the 30 year mark, the discount points could potentially save a total of $14,117.
As in most areas of finance, the best option depends on your specific situation. If you wish to move in roughly five years, avoid discount points. But if you are 98% that this mortgage is for the “forever house,” it might be wise to selection
Bottom Line: Do the Math
No matter what rates are prominently displayed in bold at the top of a quote, do the math—or find someone you trust to help you—and scrutinize all options carefully as possible. There comes a time for every homeowner when life throws an unexpected a challenge. Don’t let yours reach you before you have a chance to even begin.
Mortgage Points vs. Discount Mortgage Points In a Nutshell
This article holds a lot of meat. Let's recap some key points:
- Mortgage points are not the same as discount mortgage points.
- Discount mortgage points might save you money over the years, depending on the interest rate and how long you intend to own the home.
- While discount mortgage points can work in your favor, mortgage points are for the bank’s benefit, and will not save you money at all.
- Be thorough.
For additional tips and tricks, consider reviewing The SMART First Time Homebuyer's No-Nonsense Checklist For Buying Your First House or What is the difference between a home mortgage and home equity loan?
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