The Federal Housing Administration's mortgage insurance program paves the road to homeownership for many first-time home buyers. FHA-backed mortgages work like any other loan, and buyers often have the option of saving money on interest down the road by paying some up front in the form of mortgage points. As with most mortgage topics, the question of who pays the points on an FHA mortgage is an important one to consider before you close the deal.
Often, the Buyer Pays
Buyers who utilize FHA loans can purchase points to decrease the interest on the loan by one percent per point. Lenders may also offer a set interest rate with the purchase of a certain number of points, such as a 5.5-percent rate with one point, or a 4.25-percent rate with two points. Although there is no legal limit to the number of points buyers can purchase, most lenders only offer up to four points on a mortgage. Buyers pay for points at closing, along with the other closing costs. This prepaid interest in also tax-deductible, as long as you claim it the year you purchase the house and the property is your primary residence.
Rolling the Points Into the Loan
Although rolling the points back into the loan seems counter-productive, you can still save money on an FHA-backed mortgage by doing so. Here's a highly simplified example of how it works: If a lender offers a 5-percent interest rate on a $200,000 loan, that interest will cost you an additional $10,000 each year. If you buy a point for $2,000 and roll it into the loan, the resulting 4-percent interest rate decreases the annual interest payments on the new $202,000 balance to $8,080, a savings of $1,920 per year.
Having the Seller Pay
FHA guidelines allow sellers to pay up to 6 percent of the sales price of the home in closing fees on behalf of the buyer. This can include mortgage points, as well as other closing costs, such as appraisal, title and origination fees. As with buyer-paid points, sellers cannot purchase more than four points on the loan. If the seller pays for the points, you will not be able to claim it as prepaid interest on your tax return.
Should You Really Pay Points On an FHA Loan?
FHA loans already come with sweet deals on things such as down payment and credit guidelines, so is complicating the mortgage process with points really necessary? If you're planning on staying in your home for the long haul, then paying points up front is worth the extra savings in interest over the life of the loan. If you think you may move within a few years, purchasing points doesn't make as much sense, because you probably won't make enough payments to recoup the upfront cost.
Lauren Treadwell studied finance at Western Governors University and is an associate of the National Association of Personal Financial Advisors. Treadwell provides content to a number of prominent organizations, including Wise Bread, FindLaw and Discover Financial. As a high school student, she offered financial literacy lessons to fellow students.