There are so many things going on in a mortgage that borrowers often get confused by the terminology. One of the more commonly asked topics is the concept of points on a home loan.
In this article, light will be shed regarding the basic information about points on a home loan or mortgage points. Read on the information to find out more about it.
What are mortgage points?
Mortgage points, points on a home loan, or discount points - whatever the name is, they all mean one thing - a reduction.
The points are the fees paid directly to the lender at the time of closing the transaction and executing the contract. They are paid in exchange for a reduction in the interest rate.
Basically, the borrower pays a certain amount to “buy down the interest rate” which then leads to a lower monthly mortgage payment. It is a way for the borrower to further reduce his monthly amortization by paying off some of the interest rate early. With the interest paid upfront, there is lower interest rate that covers the life of the loan.
In a way, using mortgage points reduces the amount of the loan and stretches the dollar value even more. This is taking into consideration that home values often appreciate and owning a house is an asset to which you can take out equity on eventually.
How does one compute his mortgage points?
The tricky part is always in the computation of the mortgage points. How does one compute for his mortgage points?
One point is equal to one percent of the mortgage amount.
Hence, if you have a loan worth $100,000 and you want to get 1 mortgage point. You pay off $1,000. This reduces your interest rate is up to 0.25%, and the total balance payable is lowered.
While a single percentage off may not seem much, the following scenario should say otherwise:
- A has a loan worth $200,000 with an APR of 4.5%. Without using any mortgage points, he ends up paying $1,013.37 a month exclusive of taxes and other charges.
- If he uses 1 mortgage point such that he is able to bring down the APR to around $4.25%, he only ends up paying $983.88.
- While the computation shows a small difference of less than $30, the total savings end up at $10,616.40 over the course of a 30 year period.
Advantages of Mortgage Points
Using mortgage points comes with a handful of advantages, they are the following:
- The interest rate is deducted. If it is not clear from the illustration above, the interest rate for the mortgage decreases by 0.25% for every mortgage point paid by the borrower. This means that the overall total amount of payment is further reduced since the interest rate is lower.
- The monthly payments are lower as well. This advantage is simple math at work: with lower interest rate, there is a lower monthly amortization required to be paid. Even if the amount of decrease is as little as ten dollars, it still counts if computed over the period of 30 years.
- The total cost of the house is also reduced. This is also a simple math logic. If you pay less interest, you pay a lower monthly amortization, you eventually end up paying less for the same house.
- Mortgage points are always tax deductible. Yes, you read that right! Mortgage points are deductible as long as they are applied to the cost of obtaining the loan and not for closing the contract.
In a nutshell, mortgage points paid in advance reduce the interest rate, lower the monthly payments, reduces the cost of the house, and can be applied as a tax deduction - one will not get advantages as good as this.
Disadvantages of Mortgage Points
Of course, not everyone is perfect and even a concept can have disadvantages. The following are the disadvantages using of mortgage points:
- The borrower must be patient with the break even point. There is a term in mortgaging called the “break even point”. Basically, it views the purchase of mortgage points as an investment. As an investment, it does not make a return automatically and one must wait for a period of time before the return can be applied. In the case of a mortgage point, the borrower purchases the points, say that he pays $2,000 dollars for a 2 point reduction in a $200,000 loan, it would take him around 6.8 years before he is even to “break even” the money he spent on purchasing a mortgage point against the money he saved.
- The value of the mortgage points also decrease or may even disappear when interest rates go down. If interest rates go down to the point where the individual would have access to a lower value loan, not only would his purchase of the mortgage loan be useless, he would also miss out on the opportunity of using a lower rate.
- You have to pay upfront costs. Of course, the obvious disadvantage is paying upfront costs for the mortgage points but for those with the means, this is not a disadvantage.
Now that you know about mortgage points, the next step is to go to your trusted mortgage advisor and find out how you can personally take advantage of it. Ask your mortgage advisor today so you can start planning for a better tomorrow.
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