All About Points
Points are up-front interest. Lenders charge points as a way of being paid for the work and expense of processing and approving your mortgage. When you buy a home, the points are tax-deductible – you get to claim them as an itemized expense. When you refinance, in contrast, the points must be spread out for tax purposes and deducted over the life of the new loan.
Lenders quote points as a percentage of the mortgage amount and require you to pay them at the time you close on your home purchase. One point is equal to 1% of the amount that you’re borrowing. For example, if a lender says the loan has two points, that simply means you must pay 2% of the loan amount as points. On a $120,000 loan, two points cost you $2,400.
The interest rate on a fixed-rate loan has a direct relationship to that loan’s points. When you are able to (or desire to) pay more points on a mortgage, the lender should reduce the ongoing interest rate. This reduction may be beneficial to you if you have the cash to pay more points and want to lower the interest rate that you’ll pay year after year. If you expect to hold onto the home and mortgage for many years, this is a good deal!
Conversely, if you want to (or need to) pay fewer points (perhaps because you’re cash-constrained), you can pay a higher ongoing interest rate. The shorter the time that you expect to hold onto the mortgage, the more sense this strategy of paying less now and more later makes.
Don’t get suckered into believing that “no-point” loans are a good deal. There are no free lunches in the real estate world. Remember the points/interest-rate relationship: If you pay less in points, the ongoing interest rate will be higher. So if a loan has zero points, it must have a higher interest rate. This does not necessarily mean that the loan is better or worse than comparable loans from other lenders. However, lenders who aggressively push no-point loans aren’t usually the most competitive lenders in terms of pricing.
Want to know how this shakes out in terms of your bank account?
Suppose you want to borrow $150,000. One lender quotes you 7.25% on a 30-year fixed loan and charges one point (1%). Another lender quotes 7.75% and doesn’t charge any points. Which offer is better? The answer depends mostly on how long you plan to keep the loan.
The 7.25% loan costs $1,024/month compared to $1,075/month for the other mortgage. You can save $51 per month with the 7.25% loan, but you’d have to pay $1,500 in points to get it.
To find out which loan is better for you, here’s a formula:
Divide the cost of the points by the monthly savings ($1,500 divided by $51 equals 29.4). This gives you the number of months (in this case, 29.4 months) it will take you to recover the cost of the points.
The 7.25% loan costs 0.5% less in interest annually than the other loan. Year after year, the 7.25% loan saves you 0.5%. But, because you have to pay one point up front on the 7.25% loan, it will take you about 30 months to earn back the savings to cover the cost of that point.
So, if you expect to keep the loan more than 30 months, go with the 7.25%, one-point option. If you don’t plan to keep the loan for 30 months, choose the no-points loan.
To make a fair comparison of mortgage from different lenders, have the lenders provide interest rate quotes at the SAME point level. Ask the mortgage contenders to tell you what their fixed-rate mortgage interest rate would be at one point. Also, make sure the loans are of the same term – for example, 30 years.
5 ways to slash mortgage costs
Ready to plunk down your hard-earned cash for a slice of the American pie?
Buying a home is likely the most expensive, long-ranging financial commitment most of us ever make. The more homework you do before heading out with a real estate agent or before making an offer on a home, the more likely you are to stretch your mortgage budget.
Here are six ways to get the most bang for your money beginning before you step out the door to shop.
Get pre-approved
Get pre-approved for your mortgage loan, rather than just pre-qualified.
With pre-approval, the lender pulls a credit report, verifies a borrower’s income and takes other preliminary underwriting steps to come up with a maximum allowable loan amount. The lender also commits, in writing, to making that loan if a purchase occurs within a set amount of time. (In a pre-qualification, the customer provides the information, but the lender doesn’t check it and there’s no assurance that the loan will be approved.)
Pre-approval requires the home buyer to fill out a loan application and provide supporting pay stubs, bank statements, employment information and W-2 forms. Lenders charge for the service — generally from $20 to $50 — but it’s worth it. Pre-approval puts you in the strongest possible bargaining position with sellers! Those who are in a hurry to sell a property often will accept a lower bid from a pre-approved buyer because they can be certain the deal will go through.
Short on cash? Consider an adjustable-rate mortgage. ARMs feature lower monthly payments at first, something that might help marginal buyers get into a home.
“When you see interest rates going up, a lot of the adjustable-rate mortgages actually become more affordable at that stage in the game,” says Peter Goldberg, senior vice president of Ohio Savings Bank in Cleveland. “Ultimately people look for that lower payment and ARMs can really provide a lot of that.”
Based on a national survey of lenders, the interest rates offered for ARMs tend to be about 1.5 to 2 percent lower than the average 30-year-fixed rate. Someone borrowing $150,000 on a one-year ARM at 5.47 percent would have monthly payments in the first year of $849. The same-sized loan with a 30-year fixed-rate mortgage at 7.01 percent would cost $999 a month.
Float a balloon
Balloon loans are another option available to get a lower payment in the first few years. These mortgages charge less interest upfront for a set time frame, but require the borrower to either refinance at the end of that period, pay off the loan or convert it to a fixed payment schedule.
On a seven-year balloon loan, a borrower might make payments of principal and interest for that period of time. Assuming rates didn’t shoot up more than 5 percent in the meantime, they might then be able to pay just $250 to roll the loan into a fixed schedule for the last 23 years.
Buy down the rate
If you’ve got the cash now and want to lower your payments, you can “buy down” your mortgage rate.
It’s a simple concept, really: In exchange for more money upfront, lenders are willing to lower the interest rate they charge, cutting the borrower’s payments.
Buydowns can be temporary or they can last the life of the loan.
Trim closing costs
Of course, the mortgage rate isn’t the only thing that determines how much financing will set you back. Closing costs add a significant chunk of change to the final bill, so borrowers should try to minimize them, too.
How? For starters, consumers shouldn’t overshoot their budgets. Because the cheapest lenders often have the most conservative underwriting standards, borrowers can end up paying less in origination fees by showing some restraint.
As an example, say a couple with $52,500 available for a down payment wants to buy a $150,000 home. They might be able to qualify for a loan with just $400 in origination fees because the broker’s cheapest lender cuts deals for people who get mortgages for only 65 percent of their home values or less.
But if the same pair fell in love with a $240,000 home and refused to let it go, they would be getting a mortgage at about 78 percent loan-to-value. That’s still conservative, yet maybe not enough so for the cheapest lender. The broker ends up having to find another company willing to provide the money, and that company might charge $650 in fees.
So many people desperately need to pay top dollar for a house and that’s where they get into trouble. The cheapest lenders won’t work with them. The lower the rate that the lender has, usually those folks are real strict.
The same rule applies to other qualifying factors, such as debt-to-income ratio. A borrower who would only have to spend 28 percent of gross monthly income to get a mortgage should be able to obtain one more cheaply than a customer who would have to spend 35 percent or 40 percent.
Consumers have less control over the fees for other closing events because lenders and brokers negotiate them with various third-party providers. Somebody can’t call up the lender’s title insurance company, for example, and demand that it charge mortgage providers less for its services. But shoppers can take the Good Faith Estimate document that they receive during the loan application process and compare it with those from a couple of other companies. If a credit report costs $100 at one shop and $20 at another, but the second lender’s deal is better overall, point out the discrepancy and ask the preferred company to lower its charge.
Advantages of Home Ownership
There are two primary advantages of owning your own home:
1) You can call it your own. That means you can paint, install hardwood floors, build in an entertainment center, or put in closet organizers and mirrored wardrobe doors. You’ll also develop your own sense of community, and perhaps a little more space to raise a family.
2) Financial incentives. Home ownership is a first-rate investment for a number of reasons:
a. A sure-fire savings plan — Your mortgage payments serve as a type of scheduled savings plan. Over time, you gradually accumulate equity, as your home appreciates, and you can convert that equity into tax-free cash when you refinance. Or, you can convert that equity into a down payment for your next, better home.
RENTERS: You will continue to pay rent to your landlord with no equity, no appreciation, and no opportunty to cash-out or apply your equity towards a downpayment. The only savings plan you’ll have is what comes out of your earnings.
b. Stable housing costs — Your mortgage payment will stay the same throughout the entire time you live in your home, regardless of inflation. If you take on a $1400/month mortgage payment right now, it will still be a $1400 payment ten years from now.
RENTERS: Your rent will keep increasing, year after year. If you’re paying $1400/month right now, your rent will cost you over $2500/month ten years from now.
c. Increased value — Your home will increase in value, or “appreciate” over time. Currently, Orange County is anticipating 15% appreciation for this year. If you buy a home at $4000,000 right now, your appreciation will be $60,000 or more by this time next year (if appreciation holds true, and it should for the next few years).
RENTERS: You will experience no appreciation over the next year, and can only accumulate $60,000 if you save it out of your paycheck, or if a rich aunt dies.
d. Tax benefits — Homeowners get a significant tax break (several hundred dollars per month on an average condo) because your interest and property taxes are deductible.
RENTERS: You will experience no tax break on rent. Last, but not least, as the housing market continues to appreciate, and homes become more and more expensive, you’ll be glad if you buy now (because you may not be able to afford it later)!
How to avoid the 10 biggest mistakes people make when buying a home
1) Do your homework. Knowledge is power. There is tremendous information available on the internet to make sure you’re as prepared as possible. Visit open houses to get to know what’s available and what you like. Ask for comparable sales before making a purchase, and talk to the neighbors about the neighborhood.
2) Save the shrewd investments for the investors. Make your purchase based on what fits your family needs, not on what will happen to the market. It’s okay to do your homework and make sure you aren’t overpaying for a home, but trying too hard be shrewd can keep you out of the market.
3) Choose the best location. Even within a neighborhood, location matters. Does it back to a busy street, or is it too close to the entrance of the tract? Is your street the main access to a school? Is there a shopping center out the back window? Choose an inner tract location. For condos, end units are best for re-sale.
4) Scrutinize the interior floor plan. It may have gorgeous curb appeal. But no matter how attractive the exterior is (or the neighborhood), you need a livable home. Cosmetic fixups are easy to deal with – just make sure the floorplan itself is workable.
5) Make a needs & wants list for your family. How do you really live? Do you really need a formal dining room and living room? Would you be happier with an eat-in kitchen and a great room and a den to use as a home office? The house only needs to fit one family — yours.
6) Have a property inspection. This is not the time for surprises. Get an inspection from a qualified, respected professional. Not only will you find out what’s wrong with the home, but you’ll know the potential problems down the road.
7) Check out the builder’s reputation on a new home. Talk to three or four people who live in the builder homes and see what they have to say about how problems were resolved. (It’s also a great way to see what your neighbors would be like.)
Be patient enough to get what you want. This is a big decision. You need time. Impatient decisions can lead to mistakes. Do your research on the internet, visit open houses, and keep asking questions until you feel comfortable moving ahead with a purchase. Because once you find the right house, then you may have to move fast if there are multiple offers.
9) Shop for competitive loan packages. If you just wait for the market or interest rates to go down, you could be missing out on the perfect home. Warren Buffett says the rear view mirror is always clearer than the windshield. So take the driver’s seat, and start interviewing loan officers to see who can put together the best overall package for your loan. This will also give you the greatest negotiating position when you find the right home!
10) The biggest mistake: Not buying at all. If you can afford a home and you don’t make the purchase, you’ll lose the benefits of tax deductions, building home equity, and the appreciation in value.
