Paying points: What are they and are they right for me?

The home loan process can be complicated and confusing. There’s no doubt about that.

One of the most complicated and confusing aspects of a mortgage is deciding whether or not to pay points.

So what are points? Points, sometimes called discount points or origination points, are fees paid to the lender in return for a reduced interest rate on your home loan. Lenders call this “buying down” the rate. A lower interest rate means lower monthly payments.

A point is the equivalent of 1 percent of the loan amount. For example, a 30-year, $150,000 home loan might have an interest rate of 4 percent, but comes with a cost of one point, or $1,500.

For answers to these home-purchase questions and more, speak with a loanDepot licensed loan officer today.

The lowdown on Mortgage Discount Points

Discount points allow you to reduce the interest rate so you’ll pay a lower amount of interest over the life of the loan. Homebuyers, who plan to stay in the home long term, might want to consider discount points since it can take several years to recoup the cost. The more points you pay in advance, the lower the interest rate and, therefore, the lower the monthly payment.

Buyers can typically buy up to two points depending on the lender, all of which are tax deductible. Generally speaking, you should only pay discount points if you plan to stay in the home long term, because it can take several years to recoup the cost of paying points.

Discount points are also useful for buyers with a lot of cash, but not a lot of monthly income. For example, if you inherited a large sum of money and want to buy a home, but you only qualify for a certain amount, you can pay discount points to lower your interest rate and help you qualify for the purchase of the house. Or if you’re retired and want to downsize your home and monthly payment, paying points can be useful.

What are Mortgage Origination Points and Yield Spread Premium?

While discount points are paid upfront to lower your monthly payment, origination points, also called yield spread premium, can help cover closing costs so you avoid paying loan costs in cash, but they increase your interest rate. So you have to be clear on what’s more important to you – less cash up front or lower payments over the long run.

For example, if your home loan closing costs are equal to two percent of your loan amount, you can sometimes opt for a higher interest rate instead of paying those fees. This is called a no-fee loan. This is useful for buyers who have good income but not a lot of cash or wish to save their cash for home repairs or remodeling.

Always consult a tax professional before making financial decisions based on potential tax savings.

Lender paid mortgage insurance

To avoid paying for mortgage insurance when putting less than 20 percent down, you should explore the possibility of lender paid mortgage insurance, or LPMI. With LPMI, the lender pays the mortgage insurance premium up front in one lump sum (if this is the option chosen) and passes the cost on to you through a higher interest rate.

Pros and cons of paying discount points

There are pros and cons to paying discount points. For example, a lower interest rate, which means lower monthly payments, is one of the biggest pros. But the additional upfront cash needed and the fact that you have to stay in your home for a longer period of time is one of the biggest drawbacks.

For more information on paying points and what’s best for your situation, contact a loanDepot licensed loan officer today.

Published April 29, 2016

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