By Dian Hymer
When you shop for a mortgage you're usually looking for the lowest interest rate available. But knowing the interest rate alone doesn't necessarily give you the true cost of your loan.
Lenders often charge points for a loan. "Points" is the term lenders use for the loan origination fee. One point is equal to one percent of the loan amount. If you get a mortgage for $200,000 with a 7 percent interest rate and 1 point, you'll pay $2,000 in points at closing.
Most lenders give borrowers a choice. They can pay more points in exchange for a lower interest rate, or they can pay fewer points for a mortgage with a higher interest rate.
Although there are exceptions, the standard for the lending industry is that for each additional 1/8 percent in interest rate you're willing to pay, you can decrease your loan origination fee by 1/2 point. Conversely, paying an extra 1/2 point will buy your rate down 1/8 percent.
First Time Tip: The obvious benefit of a no-point or low-point loan is that it helps buyers who are short on cash qualify for a mortgage. Often first-time buyers have plenty of income to qualify for the monthly payments, but they have difficulty coming up with enough cash for the down payment and closing costs.
First-time buyers aren't the only borrowers who might benefit from paying no- or low-points. If you plan to keep the loan for a short period of time, you'll probably save money if you don't pay points.
Let's say you're buying a home to fix up and resell in six months to a year. A no-point loan will keep your closing costs down so that you can conserve cash to pay for renovations.
Homeowners who are refinancing often prefer no-point loans because, on a refinance, they can't write points off in the year they are paid. Points paid for a refinance mortgage must be deducted incrementally over the term of the loan. Homebuyers, however, are allowed to deduct the points paid for a purchase mortgage in the year they are paid.
Homebuyers often prefer no-point loans if they think current interest rates are high but will move lower in the near future. They can refinance when rates drop, at which time they may elect to pay points in order to buy the interest rate down even further.
When interest rates are low, like they are today, buyers are often more willing to pay points. This is particularly the case if they plan to stay in the home and keep the mortgage for at least 7 to 10 years. In this case, the money saved by paying a lower rate of interest over the years more than offsets the cost of the points.
The key to determining whether or not it's best for you to pay points is how long you plan to keep paying on the loan. If you're anticipating a quick turnover, it'll probably be cheaper to take a mortgage with no- or low-points. But, if you end up staying in the home longer than you anticipate, a no-point loan could end up costing you more.
The Closing: Ask your mortgage broker or loan agent to tell you how long it'll take for the higher interest rate on a no-point mortgage to eat up the savings you get by not paying points. If it's 5 years and you stay longer, the no-point loan will start costing you more than if you'd paid points for a lower rate to begin with.
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