When you are about to buy your first home, you are entering into a new world, complete with its own lingo and terminology — closing costs, adjustable rate mortgage, fixed rate mortgage, origination fee, PMI and points. This can be intimidating, but once you understand the terms, there is nothing to worry about. Lenders usually mention points when they are quoting their mortgage costs, but many people have no clue what points are.
A point is a fee you pay your lender. One point equals 1 percent of the loan amount. So, if you borrow $180,000 to buy a $200,000 home, one point equals $1,800, two points equal $3,600, and so on. Lenders can charge you zero, one, two or more points for two different reasons – for a discount or as a fee. If you want to lessen the interest rate on your loan, you can typically pay one to four points. This is a discount point. If you pay zero points, you do not lower your interest rate at all. Paying four points lowers your interest rate the most. Generally -- although this fluctuates -- paying one point in discount fees reduces your interest rate by a quarter of a percentage point. The other type of point is simply a fee the lender charges you to make money off the loan; this is when you shop around for other lenders to get the best deal, or try to negotiate the points with the lender.
Whether to Pay Points
Determine whether to pay discount points based on how long you plan to stay in the home and how much money you have to put down. Plug in your particular numbers to determine whether it makes sense for you to pay points by figuring how long it will take you to break even on the fees. If you don’t have extra money now, choose the zero-point option. If you do have extra money and plan to stay in your home for a long time, you might do better by choosing to pay for discount points. Generally, if you are going to be in your home more than five years, it makes sense to pay points. On the other hand, if you need to buy furniture, for example, and take out a loan to do that, you are probably better off not paying the points and buying the furniture with that money instead.
Another advantage to paying points is that you may be able to deduct all of what you pay in points on your income tax. You have to meet certain qualifications, as of 2010, such as your debt cannot exceed $1 million, this must be your main home that you purchased and not a refinance, the points were not really other types of closing costs such as appraisal fees or property taxes, and the amount on your statement must clearly state points in the amount you are trying to claim. To get this tax break, you must itemize deductions on Form 1040, Schedule A of your income taxes return. You can also pay points and get a tax deduction when you refinance your mortgage. However, the tax deduction for a refinance must be done over the life of the loan. This is not the same as one big, immediate tax break, but it should save you some tax money.
You can always ask your lender to calculate the break-even point for you if you pay points. Your lender can show you what the difference will be in your monthly payments and how long you would have to stay in the house to make it worthwhile. If you are right at the point of breaking even or just a little ahead, another option for you than paying points is to invest that money in a certificate of deposit. After checking the CD rates, you might determine that you fare better on the interest you could earn on a CD than by using that money to pay points.
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