Points Closing Costs
Below is a MRR and PLR article in category Finance -> subcategory Wealth Building.
Understanding Points and Closing Costs
Should You Pay Points?
When navigating the mortgage landscape, deciding whether to pay points can be critical. This article explores points, their benefits, and when paying them makes financial sense.
What Are Points?
A point is equivalent to 1% of your loan amount. For a $500K loan, one point equals $5,000. The initial point, known as origination, involves a fee for loan processing. This fee supports the broker, loan officers, and other operational costs. Beyond origination, additional points are prepaid interest to the lender, enabling a reduction in your interest rate and monthly payments.
Tax Considerations
Points and origination fees are tax-deductible, which can lessen their apparent cost. For instance, a $5000 point might only cost $3000 to $3500 after-tax, depending on your tax rate. It’s crucial to consider this after-tax cost in your calculations.
Reducing Interest Rates
The value of one point varies by loan type. For a 30-year fixed mortgage, a point typically reduces the interest rate by 0.25%. In contrast, shorter-term loans, like a 2-year fixed, offer a 0.50% reduction.
Calculating Breakeven
- 30-Year Fixed Loans: The breakeven period is generally 3 to 4 years. Saving money requires holding onto the property beyond this timeframe.
- Adjustable Rate Mortgages (ARMs): For 5/1 or 7/1 ARMs, the breakeven is 18 months to 2 years. Shorter fixed loans have an even quicker breakeven period of about 14 months.
For many, buying down the rate is financially beneficial, provided they don’t refinance frequently.
Misunderstandings and Market Trends
Points often have a negative perception, assumed to be unnecessary expenses. Many in the industry avoid discussing them fearing it might seem uncompetitive, but understanding their potential savings can be beneficial. With low interest rates in the past, refinancing was common, but now the focus is on long-term savings.
“Zero Point” and “No Cost” Loans
The industry often markets loans without points or origination fees. However, these costs are concealed within higher interest rates. A “no cost” loan is a marketing strategy, as refinancing inherently incurs costs.
Categories of Closing Costs
1. Origination and Points: Origination is typically 1% of the loan. Points added can further decrease interest rates.
2. Lender Fees: These include underwriting and processing. Underwriting fees can range from $350 to over $1300, with processing fees typically around $250 to $1000.
3. Third-Party Fees: Costs like credit reports, appraisals, and notaries. Fees can vary significantly depending on services used.
4. Escrow and Title Fees: These include recording, courier, and title insurance costs, varying greatly by transaction size.
5. Transfer Taxes: Applicable in some areas like California.
Prepaid Items
These are recurring costs collected upfront, such as property taxes and insurance. The decision to include an impound account affects upfront costs but provides convenience by bundling these payments with your mortgage.
Final Thoughts
Overall, expect closing costs and prepaid items to be between 2% and 2.5% without an impound account, and 2.5% to 3% with one. Understanding these elements will help make more informed financial decisions during the home-buying process.
You can find the original non-AI version of this article here: Points Closing Costs.
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