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The Ins-and-Outs of Mortgage Points, Rates and Fees

If you are looking to be approved for a home mortgage it would be prudent for you to learn and understand points, fees and rates in relation to your mortgage loan. When shopping for mortgages there is a lot you need know besides simply what style of mortgage you want or can afford. Points, fees and interest rates are the three categories of costs associated with mortgages and knowing what they all are, and what the options can be, can help you not only when shopping for a mortgage but in the years ahead when you are paying down your loan.

Purchase Points
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Points, also known as a "buy-down" or "discount points", are fees that you as a borrower will be required to pay your lender at your closing, and they represent and are based on a percentage of the loan. Each point is equivalent to 1%, so for every $10,000 you borrow you will need an additional $100. The more points you buy the lower your interest rate will be, but do not forget that this will increase the total amount of money you will need to have at the closing.

You are not required to purchase points, but many homebuyers do because it suits their needs at the time, despite the rate associated with their loan being higher than if they did buy points, but of course the interest rate will be higher. For many prospective buyers who have the extra cash on hand it does make sense for them if they foresee staying in their home for no less than three or four years.

The longer a homeowner stays in their home the greater the return they will realize from the investment in points at the closing. Because points lower the interest rate the payments that will be made are also lower and this is the savings that is realized over the long-term for the investment at the beginning.

The reduction or elimination of PMI, private mortgage insurance, can also be achieved if the home buyer increases their down payment. With a bigger down payment, the future savings is a result of a reduction in monthly payments that are a direct consequence from the smaller loan and mortgage insurance premium. If points are purchased than there is less to pay each month in interest and this too puts money back in the home owner’s pocket for other important purchases or savings. These funds can also be used to help pay down the mortgage faster over time.

The ROI associated with a bigger down payment is not affected as dramatically relative to how long a home owner remains in their house, however, often times an increase from 5% of property value to 10% is enough to make a positive difference.

People who have never been involved in home purchase may not know what would be considered long enough to make purchasing points worthwhile as opposed to a bigger down payment. In more cases than not the crossover point where the returns are fairly equal will occur in less than eight years. Keep in mind that the cross over point will be influenced by:

  • The homeowners tax bracket;
  • private mortgage insurance premiums;
  • the rate reduction they receive for a given increase in points;
  • and appreciation of their house, which affects how long they must carry PMI.

Which arrangement a home owner should choose should be based on which one affords them the greater return or savings over the long-term. A good rule of thumb is that the longer you are assured of staying in your home the more points you should invest in. If the time frame is short, you should consider a bigger down payment, but if it is lengthy, consider investing in more points.

Can Homeowners Deduct Mortgage Points from Their Taxes?

You must first understand that the current tax code does not consider points paid in cash the same as for a refinance transaction.

Points paid in cash on a purchase transaction are 100% deductible in the year the loan was closed. Points paid in cash on a refinance are deductible but the deduction must be spread evenly over the term. It is suggested that you always consult with an accountant or financial advisor regarding these deductions as tax codes change and other factors will influence your ability to make such deductions. Always eek knowledgeable advice.

Typically if financed points are not deductible as points, they can be deducted as interest. Because the loan amount is greater the interest deductions will be greater. However you must also consider that these deductions are amortized over the life of the loan and if the loan is repaid early, the unused deduction is forfeited.

One point of interest is that only in the United States can points be used. Out of sixty countries that attend the international housing finance seminar every year, no other country does this.

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