When you’re in the market for a mortgage, you’ll likely hear about mortgage points. These are fees that you can pay up front to lower your interest rate and reduce your monthly payments. However, not everyone knows what mortgage points are, how points work, or whether they should pay for points. In this article, we’ll walk you through the basics you need to know about mortgage points.
What Are Mortgage Points?
Mortgage points, also known as discount points, are fees that you can pay up front to lower your interest rate and reduce your monthly payments. Each point typically costs 1% of your total loan amount and can reduce your interest rate by 0.25% to 0.5%. This means that paying points can save you money over the life of the loan.
How Do Mortgage Points Work?
When you pay mortgage points, you’re essentially pre-paying interest on your loan. This lowers your interest rate and reduces your monthly payments, which can save you money over the life of the loan. However, it’s important to note that paying points up front can increase your closing costs, so it might not be the best option for everyone.
How Many Points Should You Pay?
The number of points you should pay will depend on your individual financial situation and long-term goals. If you plan on staying in your home for a long time, paying points can save you money in the long term. However, if you plan on selling your home in the near future, paying points may not be worth the added cost.
Are Points Tax-Deductible?
Mortgage points may be tax-deductible, but the rules can be complex and will depend on your specific tax situation. In general, points may be deductible as prepaid interest, which means you may be able to deduct the cost of the points from your taxable income.
However, the rules for deducting points can vary depending on factors such as the purpose of the loan (such as buying a primary residence versus a second home), the type of loan (such as conventional versus FHA), and the size of the loan. The rules for deducting points on a second home or investment property are different, and the amount of points that can be deducted may be limited based on the size of the loan. Additionally, the deduction for points may be subject to certain income limitations.
If you’re unsure about whether you can deduct points on your tax return, it’s a good idea to consult a tax professional for guidance. They can help you navigate the rules and determine whether deducting points makes sense for your situation.
Can Points Be Rolled into the Loan?
If you don’t want to pay for points up front, you may be able to roll them into your loan. This means that the cost of the points will be added to your total loan amount, which will increase your monthly payments but won’t require as large an up front payment.
When Should You Pay Points?
The decision of whether to pay points will depend on your individual financial situation and long-term goals. If you plan on staying in your home for a long time, paying points can save you money over the life of the loan. However, if you plan on selling your home in the near future, paying points may not be worth the cost.
How to Calculate the Savings
To calculate the savings from paying points, you’ll need to consider the cost of the points, the interest rate reduction, and the length of the loan. There are many online calculators that can help you estimate the savings from paying points.
What Are Origination Points?
Origination points are another type of fee that you may encounter when getting a mortgage. These are fees that are charged by the lender to cover the costs of processing and underwriting the loan. These costs cover the process of the lender creating the loan for you in the first place.
Can You Negotiate Points?
You may be able to negotiate points with your lender, but it’s important to understand the terms of the loan and the potential costs involved. Be sure to shop around and compare rates from different lenders to get the best deal.
When Should You Avoid Points?
If you plan on selling your home in the near future or if you don’t have the funds available to pay for points up front, you may want to avoid paying points. Additionally, if you don’t plan on staying in your home for a long time, you might determine that paying extra for points doesn’t make financial sense for you, based on your situation.
Mortgage points can be a useful tool for lowering your interest rate and reducing your monthly payments. However, they may not be the best option for everyone. When deciding whether to pay points, it’s important to consider your individual financial situation, your long-term goals, and the potential savings involved. With the right mortgage, you can achieve your financial goals and build wealth through real estate. Remember to shop around and compare rates from different lenders to find the best deal for you.
Resource Links
Consumer Financial Protection Bureau: What Are (Discount) Points and Lender Credits and How Do They Work?
Internal Revenue Service: Topic No. 504, Home Mortgage Points