What are Points?
Points are up front mortgage interest fees paid on a loan to reduce the initial interest rate. For example, a one-point loan will always have a lower interest rate than a zero-point loan. Therefore, paying points is a trade-off between paying money now versus paying money later. A Point represents 1% of the loan amount, and depending on how long you plan to stay in your home, paying points can save you a lot of money in the long run. It takes about five to seven years to recoup the cost of paying a point upfront. Here’s the math. Let’s say you take out a $100,000 30-year fixed mortgage, and you have the option of either paying 6% with no points or 5 3/4% with one point. With the 6% mortgage, your monthly payment will be $600. And with the 5 3/4% loan, it would be $584, a savings of $16 per month. After about 62 months, or a little over five years, you would have recouped the $1,000 point you paid upfront. And then you would start to benefit from the lower monthly payments.
No Point Loans
There are many reasons for choosing a “No Points — No Closing Cost” Mortgage. The following outlines some of the most common reasons borrowers choose this option.
- Lack of cash to close escrow. If you are purchasing a new home and are short on cash for the down payment, a “No Points — No Closing Cost” mortgage can save you up to thousands of dollars.
- If the estimated time you will be staying in the home is less than 4 years, while paying points and closing costs will give you a lower interest rate and a lower monthly payment, it typically takes about 4-5 years of living in the property to realize the benefit of the lower payment when weighed against the total cost of the points.
- Lack of equity in the property when refinancing. A similar situation as portrayed in item “1”. If it makes financial sense to refinance your mortgage, but you do not have enough equity in the property to add your closing costs into the new mortgage – a “No Points — No Closing Cost” mortgage could make great sense.
In a refinance transaction, points must be amortized over the life of the loan. For example, on a 30 year loan, you can deduct 1/30th of the points paid each year. If you refinance for a second time, however, you may be able to deduct the remaining unamortized points in the year you refinance the loan. Consult your tax advisor for more information.