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Is It Worth It To Pay Points To Get A Mortgage?

When you apply for a mortgage, there are a lot of things lenders consider. It's not only the borrower's credit history, but their DTI or debt-to-income ratio, the difference between their gross monthly income and their monthly expenses; but also, their bank account, their "secondary credit", and other things. Lenders do a lot of due diligence to minimize their risk as much as possible.

Another way to lower risk is to ask for more money down from the borrower and/or requesting the borrower pay points. Depending on how you look at it, this can be a good thing or a bad thing. The thing is, nothing will facilitate approval if you chose not to pony up the dough. Sure, the bank might still approve the loan, but the amount will be decidedly lower than originally estimated.

It's also important to take note of the situation lending institutions are currently experiencing. For many industries, the effects of the Great Recession have worn off significantly but not completely. However, the banking industry is in a very precarious place because it's still dealing with gigantic losses from defaulted mortgages, unpaid business loans, defaulted student and personal loans, missed credit card payments, unpaid home equity credit lines and loans, and many other debt instruments. Putting it another way, lenders are no longer running the risk of approving risky loans the way they did during the housing bubble.

The Whole Point of Paying Points

There are two types of points in a home loan, origination points and discount points. Each is typically equal to one percent of the loan amount. So, for a loan of $200,000, that comes to $2,000 per point. Origination points are used to compensate the mortgage broker, but are generally negotiable; however, these are not tax deductible. What's more, currently, most lenders are limited to the number of points allowed for many mortgage products. At present, three points are generally the maximum, though there is a possibility this ceiling will be lifted in the future. From a borrower's perspective, paying now to save a lot later makes good financial sense.
When you pay "points," you pay interest in a lump sum upfront to get a lower rate on your fixed rate mortgage. Each point costs 1% of the mortgage amount. The more points you pay, the lower your mortgage rate. So, which is the best for you? More points and a lower rate? Or fewer points and higher rate? To decide, you need to consider: (1) Whether you can afford to make the upfront payment now for points. (2) The length of time expect to have the mortgage. The longer you plan to have your mortgage, the more it makes sense to pay for points now because you'll have a long time to benefit from the lower rate.

Discount points are just that, a discount that's really prepayment of interest on the loan. For every discount point you pay, there's a discount of .25 percent in the interest rate. The majority of lenders offer up to three discount points because they want to get as much out of their investment as possible. It's also important to know that when lenders advertise low mortgage interest rates, those rates include purchased discount points. Unlike origination points, discount points are tax deductible, that is, if you itemize your deductions on the IRS Schedule A form.

Are Points Worth Paying?

Basically, paying points are discounting your interest rate, which of course, is a good thing. However, exercising this option really depends on your personal situation. Most experts state that if you're going to be in the home for many years, it's well worth the money to purchase points. If this is a short term proposition, then it's not as financially rewarding.

As an example, the purchase of a $200,000 home with a thirty year mortgage at today's rate, about 4.3 percent, would mean a monthly payment of $989.74. Now, the same purchase with a rate of 3.55 percent, equal to three purchased discount points, lowers your monthly payment to $903.68, which is a savings of $86.06 per month, or $30,981.60 over the life of the loan. That's certainly a big savings, and makes total sense to pay the upfront cost, that is, if you have the money.

This brings up another factor, which is, can you afford to pay for this upfront cost? Some financial experts say it's better to put that money into the market and realize a healthy return, while others urge borrowers to pay the points to take advantage of lowering their monthly obligations.

What it all comes down to are three considerations: will you stay in the home for many years? Do you have the money to pay for points without being financially strapped for the first several months you're in the home? Are you going to get a better deal by purchasing a less expensive home?