Mortgage points – you’ve heard the term I’m sure. But do you understand what points mean and how points can affect you? 1 mortgage points, quite simply, is equal to 1% of the total loan principal amount.
Why would anyone want to pay mortgage points? There is a simple explanation for this: lower interest rates! If you pay points, you are in effect reducing the total amount of the mortgage and the interest that will accrue on principal. For example, a lender might offer you a mortgage at 7.75% interest with no points, but offer you an option of 7.0% interest if you pay 3 points. Over the full life of a 30 year mortgage, you would save money. However, if you plan to live in the home only a short time, accepting the higher interest rate and avoiding points would be best. It usually takes 4 years or more to recoup and begin saving after paying mortgage points, although this can vary dramatically based upon the terms of your loan.
In most cases, paying mortgage points will be recouped in a few years by having lower payments. But those lower mortgage payments will extend through out the life of the loan! So you can see that paying points can save a lot in the long run.
Is paying mortgage points like paying a down payment? No, it is not. Your down payment has nothing to do with points. Normally, you will have to pay 20% of the loan amount as a down payment. Sometimes you can get a lower down payment percentage, but you will, in most situations, have to carry Private Mortgage Insurance (PMI) which costs money. By paying less than 20% down payment, paying points, but having to carry PMI for most of the life of your loan, you may not save – you may lose! You should ask your lender for a full explanation of points and PMI and how they will affect you with the type of loans that they offer.
Plan to pay 20% down payment on your mortgage. Then compare mortgage options offered by your lender which allow you to pay mortgage points if you want to lower your interest rate. One point on a $100,000 mortgage is equal to only $1,000.
If you want to determine if paying points on a mortgage is right for you, there are mortgage calculators which can calculate the break even period, or the period at which having paid points on a mortgage becomes a true savings, for you. There are numerous such tools available; one can be found for calculating break even on fixed rate mortgages at decisionaide.com.
You can also look at mortgage points as an investment. Just as with any other investment, there is a rate of return on your investment. You may want to know if you are choosing a good investment option by paying mortgage points. Perhaps placing the money in another investment would serve your needs better. To calculate the return on your investment in mortgage points using a mortgage calculator tool, simply enter the required information and you will be provided a rate of return to compare to other investment vehicles. One "rate of return" calculator can also be located by decisionaide.com.
Of course, it is necessary to have money to pay the points with, and it is not recommended that you deplete all of your emergency savings in order to pay points. If you can pay points and, after studying the break even point you find it in your best interest to pay those mortgage points, you can certainly make a difference in the monthly expenditure. Again, we can't stress enough that you should ask your mortgage lender for a full explanation of how points and PMI work with the products they offer.
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