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Holding the keys to that first home is a milestone event in the life of an adult. New home buyers can become so caught up in getting a new residence that they miss the implications of important fine details of financing a mortgage. For instance, the impact of mortgage points on their loan may get lost in the hustle and bustle of finding the perfect home in the right neighborhood. Initially, a brand new buyer might just be glad to get approved without fully exploring their options.
During the mortgage loan process, lenders require applicants to provide tons of documentation including proof of income and assets, a proper down payment, and an acceptable credit score. If things check out, they might offer eager buyers a mortgage loan with the option to purchase mortgage points. Borrowers should be just as diligent in vetting the terms contained in a mortgage loan agreement. One of the first things to consider is whether purchasing mortgage points is a favorable choice for their situation.
Mortgage points are also referred to as discount points. Lenders offer discount points to prepay some of the interest on their mortgage. Essentially, paying for points at the loan closing is a means to buy down, or reduce, their interest in advance in exchange for a lower interest rate. On the surface, that appears to be a great idea for all parties. Or perhaps it is not; all buyers come to the table with a different set of circumstances.
For each point purchased, the interest rate is reduced by a certain amount depending on the lender. The consensus is that buying mortgage points is the sensible choice for people who plan to stay in their home for the long-term.
Purchasing mortgage points is like paying interest up front, which may be of benefit to the lender or the buyer, depending on the situation. Each point costs 1% of the mortgage; the lender determines the amount of the discount and the interest rate.
Some buyers like the idea of paying a lower interest rate. The savings in interest can eventually become additional income for the homeowner once the cost for the points are paid back. In some regions, the points also come with some tax advantages.
On the other hand, some lenders know that there is little likelihood that people will live in their homes through the full 30 years of a traditional loan. When the home is sold, the lender no longer gets the interest that is written into the mortgage amortization schedule. Therefore, they may offer the buyer points up front in order to absorb money they won’t get if the homeowner sells the property early.
There are two sides to buying mortgage points. Each home purchase is different, which means all buyers should consider the following before making a decision one way or the other:
Points are listed on both the loan estimate and the closing disclosure. The points must be connected to an interest rate reduction only. New home buyers should make sure that the lender has not referred to or included any other fees or upfront costs as points.
To help decide whether points make financial sense, first time homeowners can perform calculations based upon their actual numbers. The goal is to analyze how long it would take to pay off the initial cost of the points based on how much they will save if they don’t buy points. These numbers differ between lenders since creditors offer different interest rates and terms.
To get the total picture, the upfront cost of the point must be added to the equation. If the buyer paid $2,000 for one point, they need to divide that amount by how much they will save each month to see how long it would take to recoup the extra upfront investment. In this scenario, it would take close to six years (at a rate of $30 a month) to add up to the price of the point.
Buyers can purchase more than one point to lower their monthly payment even more; the same calculations apply to determine whether buying points make sense. Once the buyer reaches the break-even amount paid for the points, any remaining lower-interest payment savings are theirs to keep. But they will only see these savings if they remain in the home for some time after they’ve paid off the points. Online mortgage point calculators make it a breeze to play around with the figures that apply to their transaction.
Another mortgage loan financial tool is negative mortgage points. The process involves payment of mortgage fees by the lender. In turn, the buyer agrees to a higher interest rate for the loan. Other names for negative mortgage points include:
Like mortgage points, each negative is point is equal to one percent of the loan. Negative points appeal to buyers that:
Lenders reduce closing fees by the number of negative points the buyer accepts. Again, it is important to run the numbers and consider future housing plans before agreeing to negative points. One expensive downside to negative points is the higher cost of the mortgage due to the increase in interest rates.
Homeownership is a major financial commitment with a lot of moving parts; each one comes with current and future financial consequences. A first time buyer will come out much better in the end with accurate information throughout the process. Far too many people have been caught up in the excitement of a new home and agreed to less than optimal terms.
The decision to buy mortgage points should not be made on the spur of the moment. If a buyer is offered mortgage points with a loan approval, they should not accept until they have calculated the costs of their situation. If the cons outweigh the pros, the buyer should be bold enough to reject the offer to buy mortgage points and find alternate means of financing if necessary.
