What are Mortgage Points?
When it comes to mortgages, a point is a very simple calculation. It is precisely 1% of the value of the amount mortgaged. If your mortgage is for $150,000, one point is equal to $1500. If your mortgage is $500,000, one mortgage point is equal to $5000. Not so complicated, huh?
How and why you might need to understand and use mortgage points is another matter entirely. There are two completely different occasions when points are important, and can have a significant impact on your mortgage.
Origination Points
The first occasion is ORIGINATION points, or the amount a lender charges to originate your mortgage (process your application and initiate your loan.) Traditionally lender have expressed this cost in terms of points. These days, however, they typically charge a flat amount, calling it an ORIGINATION FEE. Whether expressed in points or a flat fee, current ORIGINATION costs typically range from .5% to 1.5% of the total amount of the mortgage, and rumor has it that these are sometimes negotiable. Also the loan origination fee may be deductible as an itemized deduction on Schedule A of your tax return if they meet certain criteria. You may want to consult IRS Publication 530 to get more information about origination fee deductibility.
Discount Points
The second type of points associated with a mortgage is DISCOUNT points. Discount points are basically an interest percentage you pay at the beginning of the mortgage in order to obtain a reduced interest rate for the life of the mortgage. Generally, the payment of one discount point (1% of your mortgage) will result in a .25% reduction in your interest rate. So, if you choose to pay two discount mortgage points up front on what would normally be a 6% fixed rate mortgage, your new interest rate would be 5.5% (2 points x .25% per point = .5% discount off of a 6% interest rate = 5.5% rate.)
There are two factors in deciding whether discount points are right for you. First, you must decide whether you have the money available to purchase discount points up front, along with other up front costs such as down payment and closing costs. If you don’t have the funds to purchase discount points and cover your other costs, then it’s a moot point – no pun intended.
If you can afford to purchase discount points up front, then the question becomes a mathematical one based upon current interest rates and the length of time you expect to keep your new home. In a general sense, it takes five or more years just to ‘break even’ on your discount point investment, saving enough on your monthly payments to cover your up front cost. If you don’t think you will keep your new home for significantly longer than five years, then discounts points are not a good choice.
However, if you plan to stick around awhile, then you may wish to calculate when and how much discount points will save you. You can do the math yourself, or check out online discount point calculators, such as at bankrate.com. As a rule of thumb, the higher the interest rate, the greater the savings that mortgage discount points will generate. And discount points are an eligible itemized tax deduction.
Recent Changes
As a result of the financial crisis of 2008 and subsequent “mortgage meltdown”, lots of changes were enacted that changed the way mortgages are originated. One major difference was the creation of the new “Good Faith Estimate“, or “GFE”, which was intended to make charges and fees simpler for the applicant to comprehend. Since these changes were implemented on January 1st, 2010, the origination costs for loans are bundled together in a way that’s easier to understand. Prior to that, an applicants Good Faith Estimate often contained a separate “Origination Fee” (which was where the “Origination Point” was usually charged), Processing Fee, Underwriting Fee and even Wire Transfer Fee. On the new GFE, the Origination, Processing, Underwriting and all other administrative fees associating with originating the mortgage are combined into one “Origination Charge” and presented to the borrower on the first line of the second page.
These same changes also resulted in significant changes in how discount points are presented to applicants on the Good Faith Estimate, although how discount points work largely remains the same. Presently, a borrowers discount mortgage point options are clearly outlines on line two of the second page of the GFE following the words “Your credit or charge (points) for the specific interest rate chosen”.
The main point is that purchasing and financing your home is major undertaking. Be sure to research and compare your options. Shop around and do your homework on the vast array of resources and opportunities available to you in home financing today.
