Hi! Welcome back to #FabulousFriday! Many borrowers find themselves truly confused when they begin to calculate how much it will cost to purchase a new home.
First, they wonder, how much money will it cost for a down-payment--and how much are closing costs? Today, we will focus on one of the aspects of closing costs-points. The first question many buyers ask is: What Are Points, Anyway?
Here's a quick quiz...mortgage “points” are:
a) certain charges paid to obtain a home mortgage
b) the gross profit for the originator of the loan
c) up-front mortgage interest fees to reduce the interest rate
d) each equal to 1 percent of the total loan amount
e) loan origination fees
f) charged by a lender to raise the yield on a loan when money is tight, interest rates are high, or there is a legal limit on the interest rate that can be charged on a mortgage
g) come in two varieties
h) all of the above
If you answered (h), you are correct. Points are all those things and more. Points charged are often used to cover a lender’s overhead—salaries, building leases, employee benefits, unexpected expenses. As a rule of thumb, paying one point should lower the interest rate on a loan ¼ percent, two points ½ percent and so on. In most cases, a no-point loan will usually have a higher interest rate than a loan with points. In other words, paying points now means you’ll pay less interest later. Lowering the rate reduces your monthly principal and interest payment. In essence, points equal prepaid interest.
There are two types of points. Discount points are prepaid interest on your mortgage loan—you’re basically paying finance charges in advance. Discount Points are used to "buy" your interest rate lower. This is known as a rate "buydown." Typically, one full Discount Point will lower your fixed interest rate .250 percent or your adjustable rate .375 percent. These points lower the interest rate for the entire term of the loan.
The way lenders look at this type of points is that it covers the cost of a lower interest rate over the length of the loan. The more points you pay, the lower the interest rate on the loan, and the fewer you pay, the higher the interest rate. Paying discount points is a good idea if you plan to live in the house for a long time.
Often, you can deduct the points in full in the year they are paid, if all the following requirements are met:
You are legally liable for the debt and the loan is secured by your main home.
The points paid were not more than the amount generally charged in that area.
The points were not paid for items that usually are separately stated on the settlement sheet such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
You provided funds at or before closing, which were at least as much as the points charged, not counting points paid by the seller. You cannot have borrowed the funds from your lender or mortgage broker.
You use your loan to buy or build your main home.
The points were computed as a percentage of the principal amount of the mortgage, and
The amount is clearly shown on your closing disclosure statement.
Origination points may be charged by the lender for evaluating, preparing, and submitting a proposed mortgage loan (the costs of making the loan) or to boost profits. Most loan officers’ compensation is based on origination points, but they still may be negotiable in whole or in part. Some lenders add origination points into their quoted points while other lenders add an origination point in addition to their quoted points. Where discount points serve the borrower by lowering the interest rate, origination points do not.
Understanding closing costs and the money you will need to purchase you home can feel overwhelming. We are here to help. Reach out today and one of our knowledgeable, friendly Shaffer agents will be glad to meet with you and discuss the home buying process. In the meantime, I look forward to sharing more real estate tips and tricks next Friday. See you soon. Warmly, Susan