Wednesday, June 21, 2006

What are Points? And Why Pay Them?

To be honest, you don't pay points - but you do have the option to. The benefits to 'paying points' are significant for many borrowers, if they learn and know how to exercise them to their utmost value. Let's take a look at how to do that.

A 'Point' is a fee that a borrower pays the lender at the loan closing. Points are expressed as a percentage of the loan amount. So, if you are paying 1 point, and your loan amount is 100,000; you would be paying $1000.

Many people 'think' they must pay points, when in fact they do not; however, if you decide to go to a 'no-points' loan, your interest rate is often higher.

Here's a simple example:

Say your lender offers a no-points interest rate of 7%.

They may also offer the following:

6.75% and 1 point
6.25% and 2 points
6% and 3 points
5.75% and 4 points

There are hundreds if not thousands of mortgage lenders in the U.S.; all competing for a finite amount of business, lenders pay 'finders fees' to independent brokers for beinging them borrowers.

When utilizing the option of paying points, it is called 'Paying Points to Buy-down Your Interest Rate', essentially what your doing is paying directly to the mortgage broker at closing, the finders fee that the lender would have otherwise paid. This can be a positive benefit for many borrowers, but should be weighed properly with what your overall goals are.

Some borrowers have little wiggle room because they are cash-sensitive, and may need to avoid points so that they have enough money on hand to complete the deal.

Other borrowers are income-sensitive, so they need to pay as many points as possible up front, to lower their interest rate (and thus their monthly payment) so that their mortgage payment will not be excessive.

There are two other factors that should guide you, if you are not constrianed by cash or income shortfalls.

Your first question should be, how long do I realistically plan on staying in this property. If you plan on staying for the long haul, you will want to think about paying points upfront. as you will be able to benefit from a lower interest rate over the whole life of the mortgage.

If you plan on only staying for short time (less than 7-10 years), or you already envision refinancing your mortgage sometime in the near future to perform home improvements or for other cash needs (schooling for children comes to mind); you may want to avoid points and pay the higher interest rate; because you won't be there long enough to see any major differences.

You may also envision a length of stay in your mortgage because of falling interest rate expections; I do NOT recommend borrowers making decisions based upon their speculation of interest rates which you can not forecast; unless of course you own a crystal ball that works. If you do, let me know, I have some questions I need answered!

Secondly, even when you plan on staying in your home for the long haul, there may be things that you could use your money on that take priority over 'paying points to buy down your interest rate'. A useful way to compare and determine what is right for your needs, is to look at paying points to lower your rate as an investment in that shows a greater return the longer you stay in your mortgage loan.


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