Mortgage Points
One of the issues affecting government insured mortgages involves points that the seller must pay. The buyer can also purchase points at settlement in order to obtain a lower interest rate over the life of the loan.
When most people think of points, what comes to mind are those a seller pays for a buyer who obtains a government insured mortgage. Although government mortgages are the most common sources of points, they are certainly not the only mortgages that involve points. Any time there is a reduction in the standard interest rate, points are used to offset the lower interest rate. It is the method mortgage companies use in order to compensate for providing a buyer a lower rate than they would ordinarily offer. In the case of government mortgages, the seller must pay the points, but with other mortgages, the buyer pays the points unless other arrangements are negotiated between buyer and seller.
In addition to points assessed for obtaining a lower interest rate, banks may offer negative points in order to assist the buyer with settlement costs. The terms are very specific and do not allow buyers to use the funds from negative points toward the down payment. These are directed toward a certain type of borrower and may not be right for everyone. If used over a long period, you will pay high interest for what should be a short-term loan. Negative points loans are intended for those who have short-term needs, instead of those who wish to extend the payments over a long period of time.
Points are used to allow a buyer to obtain a mortgage at an interest rate lower than they would ordinarily be able to obtain. Government mortgages such as FHA or VA insured loans require the seller to pay the points. Each point is worth one per cent of the mortgage and will vary depending on the interest rate for which the borrower would qualify at the time of settlement. In other words, if a buyer would ordinarily qualify for an interest rate of 6.5%, but the current rate on a government mortgage is 5%, the seller would have to pay one and a half points (1.5% of the loan amount) to close the sale.
In the case of a conventional or non-government insured mortgage, there are customarily no points involved. However, the buyer has an option to purchase points at closing in order to reduce the interest for the life of the loan. Whether this is a wise move or worth the investment depends upon the interest rate and mortgage amount to be financed. Certainly, if you are looking toward the long term, it will save you a great deal in interest even by reducing your interest by one per cent and buying one point at settlement. The savings over the term of the mortgage can make a substantial difference in the equity of your home in the following years.
One of the most substantial expenses a homeowner faces is that of interest on the mortgage. Depending on the current trend in interest, it can cost three times the original loan amount and higher for a thirty-year fixed rate mortgage. Of course, if you finance your home for a shorter time, you will pay less interest without raising the payments much more than a thirty-year loan will cost. You need to look at the big picture in order to know what the future is going to hold for your financial future.
Purchasing points at the time of settlement can substantially lower your interest payments over the term of the loan without costing you a great deal of money. A point is equal to one per cent of the mortgage amount or $1,000 for every $100,000. The number of points you need to purchase to obtain the desired interest rate depends upon the prevailing rate of interest at the time you close your loan. The higher the prevailing rate of interest, the more points you need to purchase in order to obtain the interest rate you desire. Of course, if you have a government-insured loan, the seller is obligated to pay the points, thus the reason many sellers try to avoid selling to buyers who desire to use these mortgage funds.
Negative points, or rebates as they are often called, help a buyer pay the settlement costs on his home. The mortgage company loans a buyer the funds in the form of points to be used to cover the closing costs. These funds cannot be used for the down payment and are recommended only for those people who wish to have the loan for the short term. If you plan to use it for a long period, you will find the cost to be substantial. You need to look at the long-term cost of the loan before you consider using negative points to cover settlement costs.
Negative points can help with settlement costs for someone who is short of cash at the time of closing on the loan. It should now, however, be something that you use in order to avoid using a savings account or other available cash sources. The key is to utilize the best cash sources and not use any loan sources unless you absolutely have to do so. You want to defray the cost of settlement and not increase the amount you have to pay more than necessary. Saving money toward settlement is the preferred means, but using negative points for the short term can prevent you from having to wait to close on your new home.
There is no instance that requires a buyer to pay points—not unless you prefer a lower interest rate. Since points are intended to make up the difference between the rates a lender normally charges and the rate you are receiving, the points will be based on that difference. If you have the extra cash to buy points at the time of settlement, you will save substantially over the lifetime of the loan. On the other hand, if you resort to financing points, there may not be a savings of which to speak. To finance points in order to save interest on your mortgage is not a financially sound decision unless you do it with a short-term loan.
Before you make the decision to purchase points, you want to determine if the difference in the interest rate is worth the cost. Keep in mind that each point is one per cent of the mortgage amount, which can be substantial over the life of the loan. Of course, you also want to look at your own financial picture and determine if you have the financial resources available to buy the points necessary to lower your interest rate. Unless you have the cash on hand to buy points, it is more financially sound to close at the prevailing interest rate at the time of your commitment from the mortgage company.
Most people are familiar with government insured mortgages such as FHA and VA, especially if you have ever purchased a home using one of these methods. Many sellers do not like to accept buyers who plan to utilize a government insured loan because the provisions require the seller to pay the points. This sometimes makes it difficult for buyers who do not have money for a down payment to find a suitable home. The more substantial the difference is between the prevailing interest rate and that of a government insured loan, the less attractive these loans are to sellers. That doesn’t mean a buyer will be unable to find a home, but it will be more difficult, and sometimes the seller may attempt to raise the price of the home in order to accommodate the points.
Unlike points on conventional mortgages, there is no negotiation on government insured loans regarding payment of points. On other loans, you can negotiate with the seller to pay part or all the points you purchase, but with FHA and VA loans, the seller is required to pay the points. This increases the seller’s closing costs and makes him less likely to show any willingness to negotiate on price or assist you with your closing costs.
Since points are directly connected to the prevailing interest rate, they will fluctuate accordingly. If the market is volatile at the time, there will be a greater point fluctuation than there will be during times when it is more stable. It makes it difficult for someone who is looking to price mortgage rates since the rate is not confirmed until you apply for the mortgage and receive a commitment. Points can begin at two when you are looking and go in either direction by the time you apply for the mortgage. Sometimes, you know ahead of time what is going to happen by reading information from the Federal Reserve Bank and other agencies that control the prime interest rate, but other times, you may not know beforehand about interest rate fluctuations that will affect the value of mortgage points.
In other to avoid dramatic fluctuations in points, apply for your mortgage as soon as possible after you make your inquiry. If you begin checking the value of points even three months before you are ready to apply for a mortgage, you may find a substantial difference. Certainly, the value can go down, but it is just as likely to fluctuate in an upward motion. You want to remain as close to the original point value you researched as possible, and you can only do that if you apply for your mortgage shortly after you finish researching the point value.
You must take a look at the entire picture before you make the decision to buy points. The most important thing you must consider is whether you have the available cash to pay for the points or will be looking toward financing them. The former can save you a substantial sum of money over the term of the loan, but if you finance points, the interest you save will not justify the extra interest you will pay. Even when you look at it in terms of the deductibility of points from your income tax, financing points is not a sound financial decision.
If you are taking a short-term loan to finance the purchase of points, it may be worthwhile to research. You must be careful, however, because some lenders look down on any kind of loan that is taken to finance down payment or closing costs. Your best option is a loan against a 401K Plan since you will be putting the interest back into your account rather than the bank’s. Make sure you consider all your options before you make a final decision—ask yourself if the savings is substantial enough to take a short-term loan, or will you be just as well to pay some extra on the mortgage to save the extra interest.
Mortgage points can add a substantial amount of money to your closing costs, but if the difference is enough, it can save you a great deal of interest over the term of the loan. On the other hand, it’s important to look at the overall picture and decide on the most financial sound decision. Depending on the prevailing rate of interest, it may not make a big difference in the interest, especially if there is a point or less to consider. The higher the points, the more substantial the difference, thus the more financially sound it is to buy the points.
Choosing negative points is something that is only financially sound for short-term use. If you use negative points for long-term financing, you will pay more money in interest than you would have paid to take a short-term loan to cover the closing costs. You must also keep in mind that negative points or rebates can only be used to cover the closing costs and not your down payment. With that in mind, you have to plan to have the cash for your down payment even if you are going to use negative points. There is nothing wrong with using negative points for the short term, but their use for the long term is not financially sound because of the additional interest the loan creates.