 Personal Finance PowerPoint Presentation, Mortgage Points. Get ready to get financially fit by practicing personal finance. Most of this information can be found at Investopedia, How Mortgage Points Work, which you can find online. Take a look at the references, resources, continue your research from there. This is by Lisa Smith, updated January 14, 2022, How Mortgage Points Work. Mortgage points are used in the loan closing process and are included in closing costs. So clearly if we're in the purchasing process of a home, typically we can't put all the money down for cash upfront. Therefore, need some kind of financing, some type of loan. Points could be involved in the loan process. The term points can be a little bit confusing because they can refer to different things. And then we might have some options with regards to points. And that then is another thing that we would have to consider to see what would be most beneficial from our perspective. We might need to do some comparing and contrasting to do so. So we've got the origination points or mortgage points used to pay the lender for the creation of the loan itself. Whereas discount points or mortgage points used to buy down the interest rate of the mortgage. So oftentimes when people think about points, they're thinking about those discount points because you're talking about that decision-making process as to whether you want to put more money down upfront to pay for a lower interest rate. If you pay for a lower interest rate, then that will have a longer term effect on the payments that you're going to be making. So you've got that kind of trade-off. And it's a little bit tricky to think about what that trade-off would be to be comparing and contrasting loans that have different rates and then different kind of costs upfront. Because remember, if you're kind of adjusting the loans and you're comparing and contrasting them and you can adjust a few different things, right? You could say, well, if you have two loans and they're both the same years long, you could adjust the costs, the upfront costs, and then lower the interest rate, right? As opposed to having, you know, less upfront costs but higher interest rates, for example. And so you've got to be able to compare and contrast those two. Obviously you then have the time value of money that takes into consideration as well because you have the questions whether or not you have the cash flow upfront to pay for it upfront. And then whether or not it be worthwhile, when are you going to get basically, where's the break-even point in terms of time? When would you get paid back for buying down the rate and so on? So how mortgage points work? Mortgage points come in two variations, varieties. We have the origination points and the discount points. In both cases, each point is typically equal to 1% of the total amount mortgaged. So you can take a look at the amount and then you're going to have that 1%. So that's kind of what a point means to kind of figure what a point is. So for example, on a 300,000 home loan, for example, one point is equal to 3,000 or 1% of the 300,000. That's what it means to have that one point. Both types of points are included under closing costs in the official loan estimate and closing disclosure that come from the lender. Origination points. Origination points compensate loan officers. Not all mortgage providers require the payment or the origination points. And those that do are often willing to negotiate the fee. Origination points are not tax deductible and many lenders have shifted away from origination points with several offering flat fee and no fee mortgages. So you're seeing less of the origination points, which I think is kind of a good thing because it sounds a little bit confusing because there's a couple things that come into play here with the points. If you're purchasing a home, then sometimes you might think that the points are going to be categorized as interest in some way. And if they were interest, then you'd get possibly some tax benefits, some kind of deductibility of them. If they're not interest, then they're part of the closing cost. You might not get the same kind of tax benefits. So it's important to be able to distinguish between the two. But when you call them both points, it gets a little bit confusing. So a lot of times I think more and more they're moving away and just calling them fees or no fee mortgages. And so that would make it easier, I would believe, to be going through the closing statements for a lot of people that are looking for the tax consequences of points, for example, which for my experience or from my perspective as a tax person would be nice. So discount points are prepaid interest. The purchase of each point generally lowers the interest rate on your mortgage up to 0.25%. So now you've got the discount point. So now you are basically talking about interest that is in essence prepaid, right? So that's kind of the idea because you're paying down the interest rate. You're saying I'm going to put more money upfront to get a lower interest rate. So you can kind of think of that as basically paying kind of like the interest upfront. So most lenders provide the opportunity to purchase anywhere from a fraction of a point to three discount points. So that's the typical trend. You've got up to three points that you can pay each point representing 1% of the loan amount typically. So prior to the passage of the Tax Cuts and Job Act, the TCJA in 2017, which applies to tax years 2018 to 2025, were not tax deductible, but discount points could be deducted on Schedule A. So you've got that kind of deductibility concern or consequence. So you've got to take that into consideration for taxes. So going forward, discount points are deductible, but limited to the first 750,000 of a loan. In addition, there is a higher standard deduction. So it's advisable to check with a tax accountant to find out if you could receive tax benefits from purchasing points. So remember the whole home purchasing process, oftentimes you hear, well, you got to purchase a home because there's a tax benefit for it and so on and so forth. And it used to be a higher tax benefit because the standard deduction was kind of lower. So that means more people took an itemized. It would be easier to get over the threshold to the itemized deduction. And they actually increased the standard deduction, which is beneficial to most, you know, low to income, low to moderate income people because that should standardize the code. Because obviously most of the people that are benefiting from the itemized deductions are usually more wealthy people because you're more likely to itemize as your income level goes up. But that also means that there's less, there could be less, if you're taking a standard deduction and you buy a home and now you have the interest involved and the property taxes, there's going to be less of a benefit than you might otherwise think because you got to take into consideration the benefits you're already getting for the standard deduction and you want to make sure that you're understanding that when you go into the purchase of the home because you can falsely think, well, I'm going to get all this interest as a deduction, not realizing that the place you're starting at is one where you're taking a standard deduction. So you're not going to get quite, you know, the same kind of benefit. You're going to be able to deduct all that as an itemized deduction, but you only get the itemized or the standard. And if you had a big gap between the standard, you know, your itemized deductions and the standard deduction before, then it might not be as big a benefit. So how do you figure that? You have to actually use tax software and run projections basically to figure that in. And as you're doing that, you can consider the deductibility of points in that process. And so we will focus here on discount points and how they can decrease your overall mortgage payments. Keep in mind that when lenders advertise rates, they may show a rate that is based on the purchase of points. Clearly, if you're advertising, you have the incentive to show the lowest rates that you could offer. And so you might show the rates after you have the discount points in that case, if you're allowed to do that. But that means that you paid for basically the points upfront by in essence paying for the interest upfront. So it's a little deceptive, you know, in a case, but you can see why they would do that. Should you pay for discount points? So this is a yes-no question. I expect a yes or a no. And no, no, they're going to say, let me guess, it depends. Here we go. There are two primary factors to weigh when considering whether or not to pay for discount points. The first involves the length of time that you expect to live in the house. So when you're when you're paying discount points, you're saying, OK, I'm going to say I'm going to put more money upfront. And then and then I'm going to get a lower rate, which could mean that I paid less when I make my actual payments. So that, of course, means that you're losing out in the short run because you're putting money upfront, but you get the less money that you're paying. So as time passes, the more the better that decision is. If you plan on selling the home, though, in a fairly short amount of time, then then the whole calculation is going to be different than it would be if you're planning a whole 30 year time frame. So the first involves the length of time in general, the lower you plan, the longer you plan to stay, the bigger your savings if you purchase discount points. So if you're saying this is my home, I'm plotting my roots, I'm going to be here for 30 years. I'm going to go right through this thing then and I have the money upfront to pay the points. Then then it might be a beneficial thing or often it's much more likely to be beneficial because you got that long time frame for the rate to to outpace and make it a better situation. Even though you paid the points basically upfront, if you're going to sell the home in a shorter time frame, then you paid the points upfront and you might not have as long as time for it to kind of recoup. So consider the following example for a 30 year loan. Let's do that. On a $100,000 mortgage with an interest rate of 3%, your monthly payment for a principal and interest is 421 per month. With the purchase of three discount points, your interest rate would be 2.75 and your monthly payment would be 382 per month. So clearly you're saying, okay, it was 3% and then I purchased the points and now I'm bringing that thing on down to the 2.75, which means that the payments that I'm making due to the lower interest on a monthly basis was at 421. Now it's going down to the 382. That's good. Purchasing the three discount points would cost you $3,000. Why does it cost $3,000? Because the loan is the 100,000 and they're each at that 1%. So you got the 3,000 in exchange for a savings of $39 per month, which is the difference between the 421 and the 382. So you're putting the $3,000 upfront, but then when you make the payments, you're paying $39 less per month. So you will need to keep the house for 72 months or six years to break even on the point purchase. So that's going to be the most basic calculation. You could get more complicated on this, but obviously if you put 3,000 upfront and then divide that by the savings that you're getting each month, which is $39 per month, then you've got 70, 76, 76. They're coming with 72, but that's the most basic kind of calculator. I can then divide that by 12, which would be the six years, six years. So you can get more detailed on this if you actually kind of map this out, but that would be the quickest kind of calculation you could do because a 30-year loan that lasts 360 months purchasing points is a wise move in this instance if you plan to live in your new home for a long time. So if you're going to be there for 30 years, you're clearly passing that point and then it would be more beneficial after that point of time. So there's, you know, got that timing difference that comes into play. If on the other hand you plan to stay only for a few years, you may wish to purchase fewer points or none at all. There are numerous calculators available on the internet to assist you in determining the appropriate amount of discount points to purchase based on the length of time you plan to own the home. So you can dive deeper into more detail on it with online calculations and tools. This is a subject of debate and interest amongst many, so tools have been developed. The second factor to consider with the purchase of discount points involves whether or not you have enough money to pay for them. So clearly, if you're in a situation you're strapped for cash, that's why I'm getting a loan in the first place. I'm putting as much money as I possibly can at this point down upfront. Then you might not be able to get the points because that would mean that you would need the cash flow upfront to pay for the points in order to pay down the rate. So it's a benefit that you could have that could be beneficial, but you got to take into consideration the cash flow component. So many people are barely able to afford the down payment and closing costs on their home purchases and there simply isn't enough money left to purchase points. On a 100,000 home, three discount points are relatively affordable, but on a $500,000 loan, three points will cost $15,000 and that gets a little hectic. So on top of the traditional 20% down payment of a $100,000 loan for that $500,000 home, another $15,000 may be more than the buyer can afford. I'm sure it could quite well be more than could be. Using a mortgage calculator is a good resource to budget these costs. Using APR to compare loans. So we got the good old APR comes into play here and that's supposed to give us some kind of standardization, even though we've got these differences in rates and upfront costs and whatnot. So comparing different loans with varying interest rates, lender fees, origination fees, discount points and origination points can be difficult. But sure can the annual percentage rate the APR figure on each loan estimate helps make it easier for borrowers to compare loans, which is why lenders are required by law to include it on all loans. So the APR is kind of, you know, again, you can have like a similar type of loan, like a 30 year loan and so on. But then you can have differences in the rates which are compensated for as we kind of seen here with the points are compensated for with the fees. So you could you could try to adjust your loans by increasing the fees in order to get a lower rate, for example, or you can have points involved that you could be purchasing the points in order to buy down the rate. But then the question is, well, how do I make these comparisons from one loan to another loan and so on and so forth. It gets a little confusing because I can't just compare the rate and the loan amount because now I've got these different upfront costs and that messes it all up. Well, you could try to roll everything into one number and that's basically kind of what the attempt of the APR is. So the APR is not the interest rate on the loan. It's an attempt to kind of roll in the costs and so on into one number. So you have a number that's comparable. It's not perfect. It's only one calculation. It's one tool. It's a good tool that you can kind of use to do comparisons of different loans that have different upfront costs and so on. So the APR on each loan adjusts the event at the advertised interest rate on the loan to include all discount points fees or origination points and any other closing costs for the loan. So the metric exists to make comparisons easier between loans with widely different discount points, interest rates and origination fees. So when you're trying to figure how much you're going to pay and so on, how much interest, then you got to use the interest rate. But when you're trying to say, is this loan comparable to this loan, which loan is better, even though they have different amounts of closing costs and points and whatnot, then you could try to use that APR as one tool for that comparative process. It's a little difficult still because you might, depends on how long you're going to hold the home and so on and all that kind of stuff too. So it's one tool that you can dig into though. Are mortgage points worth it? Again, I'd expect a yes or no, but no, you got this whole, we'll discuss it for a while. I want a yes or no. So though money is paid on discount points could be invested in the stock market to generate a higher return, the amount saved by paying for points. So in other words, people that are saying that points are not worth it, make the argument that you could take that money and put it into the stock market possibly and make a return higher than that that you would get on the points. But obviously there's more of a risk to put it in the stock market. So you got that kind of risk reward. The average home homeowner's fear of getting into mortgage, they can't afford outweighs the potential benefit they may accrue if they managed to select the right investment. So if you put it into the points, you're probably more on the on a like a conservative or risk averse kind of standpoint because you're probably saying, hey, look, if I can put the money down up front, and I can make my mortgage payments lower and in such a way that I know I can make my mortgage payments, then a lot of people might feel that I have more insurance myself that I can at least make the mortgage payments. And that might be worth more to people than putting it into the market and trying to get a higher return on the market than the interest rates would be because again, the higher return isn't guaranteed on the market. So it just it there's a risk risk tolerance reward and cash flow factor involved in many people's decision making process there. So in many cases, paying off the mortgage is more important. So also keep in mind the motivation behind purchasing a home, though most people hope to see their residents increase in value, few people purchase their home strictly as an investment. So when you're purchasing the home, you're not, you know, most people aren't going I'm going to I'm going to purchase the home because it's it's primarily an investment. It is primarily a home that you're going to be living in for a long period of time and using, you know, as the home, not basically as an investment tool. So you're trying to possibly buy some insurance on the home to make sure that the home will be there. And that would be more on the points side of things. If you are buying the home and property more on the investment side of things, and you're taking more of a risk kind of investment strategy, then you would think that more likely you'd be on the argument that that if I can get a better return on the point somewhere else, then I would be doing that from an investment perspective. If your home triples in value, you may be unlikely to sell it for the simple reason that you then would need to find somewhere else to live. So if you're thinking about if my home if my home goes up in value, great. But really that doesn't have a real big impact for most people if their home goes up or down in value as long as they can make the mortgage payments, because if they can make the mortgage payments and they're happy about where they are, then it's not going to change their cash flow. Although, of course, if the home goes up in value significantly, you could refinance you could try to dip in to some of that cash and so on in that way or sell the home. But again, for most people they're thinking the home is where I'm going to be for a long period of time. I've got the cash flow to pay for the mortgage. So as long as that's the case doesn't matter what happens with the market because you're locked in and you're fairly content in that case. Although increases and decreases in the housing market can cause havoc, you know, personally when you're considering when you're thinking about it. But if your home gains in value, it is likely that most of the other homes in your area will increase in value too. So that means if you like where you're at and your home goes up in value, great. But the only way to take advantage of that and still be in the same location you're at would be to sell the home there and then buy another home in your area, which would put you not in a better situation. You'd have to sell your home and then go somewhere else where the home was cheaper, but she oftentimes don't want to go somewhere else because that's why you bought the home. And the current place that you're at. So if that is the case, selling your home will give you only enough money to purchase another home for nearly the same price. Also, if you take the full 30 years to pay off your mortgage, you will likely have made nearly triple the home's original selling price in principle and interest cost. And therefore you won't make much in the way of real profit if you sell at the higher price. Bottom line then purchasing a home is a major financial decision. It sure is. We've been thinking about it a lot here. Plan carefully. Look at the numbers before you start shopping. Decide on the monthly payment amount that you can afford and determine exactly how you will get that payment, whether it's by making a large down payment, purchasing discount points or buying a less expensive home. Then be sure to shop around. Don't settle for the first mortgage package that you stumble across. You want to hold out and check things out, do comparisons and stuff. There are plenty of banks to choose from and numerous resources including real estate agents, mortgage brokers and the internet to help you shop for the best deal for your situation. Origination points are usually avoidable and negotiable, so don't spend too much on them. So those origination points, those are the other kind of points. And then so then you got the discount points can save you a lot of money over the life of the loan, but only if you can afford to buy them without lowering your down payment below the 20% and having to get a private mortgage insurance, the PMI. So I mean, if you have the 20% down payment and then you're going to buy the points, but you have to dip below the 20% down payment, which means then you'd have to buy the mortgage insurance, which kind of takes away from the benefit that you would get from paying down the points. So if you don't have the cash flow, then you might not be able to pay the points upfront. The option wouldn't be there. And then it is what it is.