Definition
Loan Points, also referred to as Discount Points, are upfront fees paid directly to a lender at closing to reduce the interest rate on a loan. One point typically costs 1% of the total loan amount and can lower the interest rate by approximately 0.25%. Paying points can be beneficial for borrowers who plan to own the property for an extended period, as it can lead to substantial savings over the life of the loan.
Examples
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Home Purchase Scenario:
- Borrower takes out a $200,000 mortgage.
- To lower the interest rate from 4.5% to 4.25%, they pay 2 points (2% of $200,000 = $4,000).
- The reduction in interest rate results in lower monthly payments.
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Refinancing Scenario:
- Current mortgage balance is $150,000 with a rate of 5%.
- By paying 1 point ($1,500), the borrower can reduce the rate to 4.75%, lowering their monthly payment and long-term interest expenses.
Frequently Asked Questions
Q: What are the benefits of paying loan points? A: Paying loan points can reduce your mortgage’s interest rate, resulting in lower monthly payments and overall interest costs over the life of the loan.
Q: How do I determine if paying points is worth it? A: Consider your time horizon in the property. Calculate the breakeven point where the upfront cost of points equals the savings gained by the reduced interest rate. This involves dividing the cost of points by the monthly savings.
Q: Can loan points be negotiated? A: Yes, sometimes loan points can be negotiated with your lender. It is advisable to shop around and compare offers from multiple lenders.
Q: Are loan points tax-deductible? A: Generally, the IRS allows homeowners to deduct mortgage points in the year they are paid if certain criteria are met, such as the loan being on your principal residence.
Q: Are there disadvantages to paying loan points? A: The primary disadvantage is the initial cost. If you move or refinance before reaching the breakeven point, you may not recoup the investment in the points.
Related Terms with Definitions
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Closing Costs: Fees and expenses paid at the closing of a real estate transaction, which may include loan points, origination fees, appraisals, and more.
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Mortgage Rate: The interest charged on a mortgage, expressed as a percentage of the loan amount.
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APR (Annual Percentage Rate): The yearly cost of a loan, including interest and other financial costs such as points and fees, expressed as a percentage.
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Origination Fee: The fee charged by a lender for processing a new loan application, which is typically a percentage of the loan amount.
Online Resources
- Investopedia: What Are Mortgage Points?
- Bankrate: How Mortgage Points Work
- NerdWallet: Mortgage Points
References
- IRS Publication 936 (Home Mortgage Interest Deduction)
- Consumer Financial Protection Bureau (CFPB) Guides on Mortgage Loans
Suggested Books for Further Studies
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“The Mortgage Encyclopedia” by Jack Guttentag - A comprehensive guide to understanding the intricacies of mortgage loans, including loan points and other loan components.
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“Home Buying Kit For Dummies” by Eric Tyson and Ray Brown - Provides a helpful overview of all aspects of the home-buying process, including detailed information on mortgage financing and loan points.
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“The Loan Guide: How to Get the Best Possible Mortgage” by Casey Fleming - Offers insight into how to secure the best mortgage terms and explains how loan points can be a part of that strategy.
