Definition of "Points"
An upfront cash payment required by the lender as part of the charge for the loan, expressed as a percent of the loan amount; e.g., '3 points' means a charge equal to 3% of the loan amount. When points are negative, the lender credits the borrower or the mortgage broker. Negative points are termed '''rebates.' When retained by a mortgage broker, they are termed 'yield spread premiums.' Points and Rebates as Borrower Options: The points/rebate system is unique to the U.S. It offers borrowers more options at the cost of greater complexity. The following is a typical schedule for a 30-year fixed rate mortgage: 5.375% and 2.75 points 5.50% and 2.0 points 5.625% and 1.375 points 5.750% and 0.75 points 5.875% and 0.125 points 6% and 0.5 rebate 6.125% and 1.0 rebate 6.25% and 1.5 rebate 6.375% and 2.0 rebate 6.5% and 2.3755 rebate. For borrowers who have the cash and expect to remain in their house for a long time, paying points to reduce the rate makes economic sense. The benefit from the lower rate extends over a long period. In addition, borrowers who have difficulty qualifying because their income is low relative to their monthly housing expense may pay points to reduce their monthly payment. In contrast, borrowers with a short time horizon do better with high-rate/rebate combinations because they don't pay the high rate very long. In addition, borrowers who are cash-short prefer to pay interest rates high enough to command rebates, which can be used to cover their settlement costs. Paying Points Versus Making a Larger Down Payment: An advantage of viewing the payment of points as an investment decision is that it allows you to compare the return from paying points with the return from increasing the down payment. Financing Points: Points can be included in the loan amount, but usually it isn't a good idea if you can avoid it. On purchase transactions, financing points spreads the tax deduction over time, whereas points paid in cash are deductible in the year paid. Financing points is worthwhile only where the savings rate is above the mortgage rate and the tax rate is low. The break-even periods shown in the table on the previous page assume that financing the points does not raise any other costs to the borrower. Borrowers should be wary of the following exceptions. First, the increase in the loan amount might bring it from an amount below to an amount above the maximum size loan eligible for purchase by the two government-sponsored entities, Fannie Mae and Freddie Mac. In 2003, the maximum was $322,700. Rates are higher on loans exceeding the maximum. Second, the increase in the loan amount might bring it into a higher mortgage insurance premium category. Mortgage insurance premiums are based on the ratio of loan amount to property value, with three premium categories: 80-85% (the lowest), 85-90%, and 90-95%. If the larger loan that results from financing the points triggers an increase in the interest rate or the mortgage insurance premium, there will be no break-even.
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