What are mortgage points? Should you pay points on your loan? Should you pay points or take a higher interest rate? Before a loan is finalized for your investment property, there are a few details related to "points" that need to be worked out.
Overall, paying points or not on your loan depends upon how long you're going to keep the property and the mortgage on that property.
In order to approve your mortgage loan, some lenders require you to prepay a portion of the interest due on your mortgage. These prepaid interest costs are referred to as “loan discount points” (or simply “discount points”) and are assessed at closing by the lender.
You pay these points in order to reduce your mortgage interest rate and your monthly payments. And the more points you pay, the lower your interest rate will be. Each point is equal to 1% of the loan amount. For example, 2 points on a $100,000 mortgage would cost $2,000.
You can negotiate with lenders how many points you pay. The advantage, from their point of view, is that they collect some of their interest earnings upfront and right away. Plus, the more points you pay, the more money the lender makes on your loan upfront.
You can pay these costs either upfront to the lender, or you can choose to have it included in the loan amount. Some people prefer to pay the fee right away to reduce their interest rate, or what is called “buying down the rate.” But others insist that it is more advantageous to keep upfront costs low in exchange for a slightly higher monthly payment.
This decision usually depends on the duration that you’ll be occupying the property you intend to purchase. If you plan on keeping the property for only 2 or 3 years, you probably won’t enjoy any benefits from paying the fees upfront. However, if you plan to keep the property on a long-term basis—let’s say 10-15 years—you should probably pay points right away.
In addition to lowering both your interest rate and monthly payments, prepaid interest is tax deductible. However, the fee will not appear when your lender does your year-end accounting of your interest payments. Therefore, you’ll need to keep your HUD-1 form from closing to give to your accountant.
So, are you required to pay points? Not at all, especially if you have excellent credit. But if you have bad credit, then most lenders will require you to pay points to approve you for a loan.
Paying points can be highly beneficial—and even necessary—if you lack enough funds and are unable to qualify for a mortgage loan.
For instance, say a lender charges Bertha 6.25% (which is under the maximum rate allowed) but she cannot meet the necessary ratios. If she pays 1% (or 1 point) of the loan, the lender will be able to reduce the interest rate for the entirety of the loan period to 6%, thus allowing Bertha to meet ratios and save a handsome amount of money.
But if you’re in a position where points are not necessary, and you want to pay them anyway, you’ll have some factors to consider. You should determine if the value of the prepaid interest is worthwhile and if you will be able to recover from the expense. Therefore, it is extremely important to compare loan offers that include points against those that do not. This way, you’ll gain a slight understanding of what benefit, if any, this expense entails.
If you gain nothing from points, then don’t pay them. This is especially true if the points are simply going to your mortgage broker as bonus revenue. You should benefit from them too, so find out where exactly the fees you pay are going.
Also, you’ll want to consider how long you’ll be keeping the property you intend to purchase, as mentioned earlier. This relates to how you’ve defined your goals and how you plan to get there.
Mortgage points aren't offered by every bank or lender, so don't be afraid to seek out a lender that offers you a better deal and then you want even have to deal with all these "points".