SHOULD YOU PAY POINTS?

These days, it's more important than ever to read the fine print and understand all the aspects to any mortgage. Your mortgage lender will always be willing to answer any questions you may have about any options, including that of paying points on the loan...

First of all, do you know what points are? A (discount) ?point? in mortgage language is equal to one percent of the amount of the overall mortgage loan. You usually pay these up front in order to reduce the interest you will pay on the loan. For example, three points on a $150,000 loan would equal $4500. A discount point usually lowers your interest rate by about .125 percent. So on an interest rate of 7.5% for example, paying a point would lower interest to 7.375%, and if the loan were for $100,000, that point would cost you $1,000.

You can deduct the money you pay for points on your income taxes for the year you close on the mortgage. Note that this applies to new mortgages only. If you're looking to pay points on a refinance, it's considered prepaid interest and has to be deducted over the life of the loan. In order to take a tax deduction on points it must also be on a loan on your primary residence. Points are not deductible for a 2nd home or vacation home.

If you are the seller, and want to pay points for the buyer to help the process along with the lender, you can?t count that as mortgage interest for you (i.e. a tax deduction), but you can subtract it from any profits you might make on the home. If you pay off your loan early and end up paying a prepayment penalty; that would be considered fully deductible mortgage interest.

The question as to whether or not you should actually pay points boils down to how long you plan to be in the home. You should determine how much you can pay in points, decide how many months it would take to break even on the payment, and how long you intend to be in the home. Talk to your mortgage broker about when you might break even, or do a search online for a mortgage points calculator.

For example, let's say you have a 30-year fixed rate loan for $100,000 with 6% interest, and you are thinking about paying two points (at a cost of $1000 each so $2,000 total) to reduce the interest. According to one mortgage points calculator, this would reduce your payment by about $20 per month. This means it would take around 100 months, or a little less than 8 and one-half years for you to break even. If you're planning to sell the home before that, paying points would not be worth the cost.

You may also want to think about what else you could do with the cash you plan to spend on points. Do you need to purchase appliances for your new home on a high interest credit card? You may be better off using your cash to buy those new appliances instead of paying points.

If you?re finding the whole issue of points confusing, be sure to ask your mortgage broker to explain further. Don't sign on the dotted line until you do understand.

Article pulled from Fairfield Financial newsletter.