Have you ever wondered where a point enters into the equation? Though it can be very confusing, don't overlook the number of points you pay on your mortgage. Even a lower interest rate mortgage can go from being a great deal to a bad one because of points. Let's see if we can un-muddy the waters where points are involved and give you an edge when you are shopping for a mortgage.
First of all, what is a point? A point is 1%, period. If you were receiving a $200,000 mortgage on your home that called for a 1-point payment at closing, you would be paying 1% of $200,000 or $2,000.
More commonly, a mortgage writer will charge you 2 or 2 1/2-points. With a 2 1/2-point charge, a $200,000 mortgage will cost you, 2 1/2% of $200,000 or $5,000.
You may wonder what happens at your closing. Does that $5,000 come right out of your pocket and go directly into the lender's pocket? Not exactly: in the case of a refinance, the $5,000 is taken out of the cash back you would receive at closing, but when purchasing a property, the $5,000 is added on to your mortgage principle amount. In other words, that $200,000 mortgage at 2 1/2-points becomes a $205,000 mortgage.
Now, let's suppose you were offered this $200,000 mortgage with 2 1/2-points charged at a 6% interest rate and the loan was for 30 years. At the same time, another lender offered you a $200,000 mortgage at 7% for 30 years but this mortgage was a 0-points mortgage. Which is the better deal for you?
With the 0-point mortgage, $200,000 at 7% over 30 years, your monthly payment would be $1,330.60. To pay the entire mortgage off making monthly payments for 30 years would cost you $479,016.00.
The 2 1/2-point mortgage, which amounts to a $205,000 mortgage at 6% over 30 years would only require a $1,229.08 monthly payment. To pay this mortgage in full by making monthly payments for 30 years would end up costing you $442,468.80.
As you can easily see, if you were looking for a mortgage for the long haul, the 2 1/2-point, 6% mortgage would be the way to go. Your required payment would be less by a little over $100.00 each month and after the entire mortgage was paid 30 years later, you would have saved $36,547.20.
So, it looks like a no-brainer, you should go with the lower interest rate mortgage every time. Right? Well, not every time. What if you intended to sell this property very soon for a quick profit, a technique known as flipping?
If you only owned the property for a few months and only made a total of 2 payments on it, you would not have paid off any principle to speak of. So, with the profit you made from selling your property, by taking the 2 1/2-point mortgage, you would be paying off the $205,000 at closing.
You wouldn't have to pay the extra $5,000 if you had taken the no-point mortgage and so at closing, you would be paying $200,000. Hence, more profit for you!
If you were in the business of buying fixer-uppers and living in them while renovating them, you probably would be selling the property in less than 3 years. Sometimes you wouldn't need to hold the property for anywhere near 3 years. In a case like this, the 7% 0-point mortgage would be the more cost effective mortgage for you.
If you sold the property in 3 years exactly, neither mortgage would be a clear-cut money saver. At closing, you would owe $3,518.41 more on the 6% 2 1/2-point mortgage but you would have paid about $3,600 less in monthly payments because, as you'll remember, the 7% no-point mortgage has a monthly payment that is about $100.00 higher.
What might swing the advantage to the 7% mortgage in this case, is that the interest portion of your monthly payments are tax deductible. So, since the 7% mortgage requires more interest be paid, you would have a somewhat larger tax deduction.
The logical conclusion is, if you are getting a mortgage that you are sure you will only need for a short time, try to get a 0-point mortgage. If you are going to have the mortgage for a long time, the lower interest rate is definitely the way to go.
The break-even point between 0-point and 2 1/2-point mortgages used to be at about 5 years. Now, in this lower interest rate environment, it is more like 3 years.
If you are intending to keep a mortgage for 3 to 5 years, the only way you would know for certain which would be the better choice would be to know how long you will need the mortgage for and then look at the proposed mortgages' amortization tables.
There is one last word of caution. If you have decided that you will only need the mortgage for a short time and therefore intend to take the 0-point mortgage, make sure you will have no problem paying the higher monthly payment on time. Paying a $50.00 monthly late charge every month will throw all the calculations off as well as risk your good credit rating.
Also, be very sure you are getting a mortgage that doesn't have a pre-payment penalty. A pre-payment penalty would mess up the whole deal altogether.
Lenders calculate mortgage interest rates on three major factors - down payment, credit history and the current economic market. Sometimes your rate is negotiable, and other times you may just have to settle for a higher interest rate. Keep reading to learn why your interest rate is high and how you can reduce it in the future.
Why is my mortgage interest rate high?
1. Low Down Payment
Typically, the lower the down payment, the higher the interest rate that will be required of the lender. If you can walk into a lender's office with an amazing down payment of 20 percent, you won't have to pay mortgage insurance, and you'll be in a much better position to negotiate a lower interest rate. A slightly lower rate may not sound like much on the surface, but the difference over the live of a loan can be tens of thousands of dollars in savings!
The inverse is also true, though, about the amount of a down payment. A low down payment of 5 percent will mean you'll have to pay for mortgage insurance and you'll be given that higher rate.
2. Poor Credit Rating
Lenders base the bulk of their lending decisions on your credit report and score. If you're a high-risk borrower, meaning you have a history of not paying your debts on time or you have credit delinquency, you'll either be denied a loan altogether or offered a much higher interest rate.
Because lenders see you as a greater risk, they are essentially 'hedging' their bets by increasing your interest rate. If your credit's poor, you may have to settle for a higher rate. To improve your credit, take at least a year (two is better) and focus on paying every existing bill on time every time. Within 12-24 months, your credit will improve, and so will your offered interest rate.
3. Economic Markets
Lenders base their interest rates on an economic index or standard. In the United States, lenders use the Cost of Funds Index (COFI), London Interbank Offered Rate (LIBOR), 12-Month Treasury Average (MTA), Bank Bill Swap Rate (BBSR), Constant Maturity Treasury (CMT) and the National Average Contract Mortgage Rate upon which to base their interest rates.
If market interest rates are high, then the rates offered by lenders are also going to be high. If you're facing an economy with high interest rates, you may want to wait until rates lower again before shopping for a home mortgage. Doing so may not get you out of a rental situation as quickly as you'd prefer, but the money you save through patience may make biting the bullet worth the wait.
How can I get a better rate in the future?
It may be possible to renegotiate or refinance your mortgage at a later date. Once your credit has improved, built up equity in your home, and interest rates have declined, you can shop around for lower rates. Interest rates constantly fluctuate, so don't become overly anxious and consequently jump into a mortgage pre-maturely.
Basically, refinancing or renegotiating a mortgage means you pay off your old loan and sign for a new loan. You can either do this with your existing mortgage provider or shop for a new one. If you move to a different lender, you may have to pay an early payment penalty. Investigate this before making your move.
Both Ed Lathrop & Jack Burnette are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
Ed Lathrop has sinced written about articles on various topics from Wedding Photography, Mortgage and Adware. Ed Lathrop is a successful Real Estate investor. He has developed EzCalculator, a Mortgage Calculator that calculates anything to do with mortgages, shows you how to pay off credit card debt and much more. EzCalculator includes the famous ?How to Make $. Ed Lathrop's top article generates over 14800 views. to your Favourites.
Jack Burnette has sinced written about articles on various topics from Mortgage, Free Credit Report Score and Finances. For information on practical home mortgage recommendations, please visit www.home-mortgage-preparation.com, a popular site providing great insights concerning home loan considerations such as. Jack Burnette's top article generates over 4400 views. to your Favourites.