When does it make sense to use a no-point mortgage

If you’ve been shopping for a mortgage, you’ve probably found there is a range of interest rates available depending on how many points you’re willing to pay. The more points you pay, the lower the interest rate.

‘Points’ is a term used by the lending industry to refer to the loan origination fee. One point is equal to one percent of the loan amount. On a $200,000 mortgage with a one point fee, you’ll pay a $2,000 loan origination fee at closing.

No-point mortgages are available but at a higher interest rate. The interest rate on a no-point mortgage will be about 1/2 to 5/8 percent higher than it would be on a mortgage where the borrower pays one point.

No-point mortgages are popular with buyers who are short of cash. In addition to a cash down payment, buyers must come up with enough extra cash to cover their closing costs. Closing costs are usually set by local custom and they vary from one location to the next. Buyers often pay for such things as lender’s title insurance, the fees associated with their new mortgage including points, inspection fees, transfer taxes (if there are any, and these are sometimes shared between the buyer and seller), and homeowner’s insurance for the first year of ownership, to name a few.

Points can add significantly to the amount of your closing costs, particularly if your mortgage amount is high. One point on a $300,000 mortgage is $3,000; its $4000 on a $400,000 mortgage. A sure way to reduce your closing costs is to take a no-point mortgage.

Buyers who have the cash, however, might prefer to pay points and take a tax write-off. Homebuyers who itemize deductions are entitled to deduct points paid for a purchase mortgage in the year the points are paid. This can amount to a sizable one-time write-off if the mortgage amount is large. Other benefits are a lower interest rate and lower overall financing costs. A buyer who pays points can end up saving money if the property isn’t sold too quickly.

FIRST-TIME TIP: Whether or not it makes sense to pay points, even if you have the cash, depends on how long you plan to keep the mortgage. The longer you plan to stay in the home, the more it makes sense to pay points. Ask your loan agent how long you’d have to keep the loan in order to recoup the cost of paying points. Or you can easily do this calculation on your own.

Let’s say you’re trying to decide between two 30-year, $200,000 mortgages: one with one point and an interest rate of 7 percent and another with no-points and a 7 1/2 percent interest rate. You plan to stay in your home for at least five years.

The monthly payment is $1398 on the 7 1/2 percent loan and $1330 on the 7 percent loan-a difference of $68 per month. Multiply $68 by 12 to determine the annual cost difference between the two loans ($816). Then divide the points ($2000) by $816. The result (2.45) is the number of years you’d need to keep the one point mortgage in order to recoup the cost of paying one point (not including tax benefits). If you were to move or refinance within 2.45 years, you’d be better off with the no-point loan.

THE CLOSING: Some borrowers go for a no-point mortgage if they think interest rates are going to drop. They’ll pay points later to refinance at a rate they feel they’ll want to keep long term.

This article was written by Dian Hymer: author of “Starting Out, The Complete Home Buyer’s Guide,” Chronicle Books

For more information on how to choose a 30 year loan or a 15 year loan click here.

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Nancy Hankin
www.PalmSpringsHomesAndEstates.com