Buying Down Your Interest Rate
What do “points” mean? Quite simply, they are fees and they came by this name because they equal one percentage point of the loan amount. For example, for each point that you agree to pay at closing, the lender agrees to reduce the interest rate on your loan by a set amount, (generally an eighth to a quarter of a percent), this is why paying points is often referred to as a “buydown.” You are simply purchasing a lower interest rate.
Points are similiar to another fee you’ll see on your closing statement, the loan origination fee. Sometimes it is called an origination point because it is also expressed as a percentage of the total loan amount. An origination point on a $200,000 loan is also $2000, but it has a different purpose; it covers some of the lending institution’s cost in preparing the loan application process, including paying office personnel.
Another important difference between origination points and discount points: discount points on new mortgage loans are usually tax-deductible, depending on your particular tax situation, while origination points are not tax-deductible. So, if your closing statement shows an origination point, you may want to ask that a discount point be substituted instead. Ask your accountant for advice on this.
Should you pay discount points? Points are for long -term gain. Here are some tips on whether you should pay them:
1. If you are cash-strapped at closing, paying points may not be worth saving a small bundle in interest over many years.
2. If you’re not planning to live in your home very long, skip the points. You will never realize the savings.
3. Use a mortgage calculator to gauge for yourself whether points are a good idea and to see how long it takes to break even.
Whether you are a buying a home or selling a home, this is a good reference to point out.
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