The Home Mortgage Process Explained

When you are shopping for a mortgage, the single most important thing to remember about ‘mortgage points’ is that there is more than one kind. There are three different mortgage-related meanings for the term ‘mortgage point,’ and you must understand exactly which type of mortgage point your lender is talking about when discussing your loan. After all, you’re the one who will pay the mortgage points and figure out which ones are tax-deductible. The first definition of a mortgage point is mathematical. In the mortgage industry, a ‘mortgage point’ means 1.0 percent of an amount of money, explains Doug Duncan, chief economist and a senior vice president for the Mortgage Bankers Association. For example, for a $100,000 loan, one mortgage point would equal $1,000. If the loan were for $173,500, one mortgage point would be $1,735, and so on. The term mortgage point also can refer to prepaid interest or to fees for loan-related services, or both. Duncan explains the most common meaning of mortgage point – often referred to as one discount mortgage point — ‘is simply prepaid interest. If a lender can receive part of the interest payment upfront, he or she will often lower the interest on the rest of the debt.’ Most lenders will gladly trade pre-paid interest in return for a lower rate because no one really knows how long the loan will actually last. Will the buyer sell the home or refinance it in one year? In five? Few mortgages last the full 30-year term of the loan. ‘Let’s say you took out a $100,000 mortgage today with no mortgage points at 5.5 percent for 30 years,’ Duncan says. ‘If you are willing to pay one mortgage point of prepaid interest — $1,000 up front — the lender will lower the interest rate because you have increased the certainty of getting a return on investment-a profit.’ This is not the only way the term mortgage point is used, Duncan adds. ‘Sometimes lenders will characterize other expenses in the same way, as a percentage of the loan.’ Rather than putting an actual price tag on costs such as origination fees, document preparation charges, and all the other expenses involved in getting the money, lenders often express them in terms of mortgage points.

So instead of setting a fixed price, the lender gives the charges a value that is a percentage of the total borrowed, charging you two mortgage points, three mortgage points, three-and-a-half mortgage points or even more to get the loan. The amount of paperwork doesn’t change, and neither does the time spent working on the deal, but some lenders make sure the costs match the size of the loan. It is important to remember that these mortgage points have nothing to do with return on investment. They are just a convenient way for the lender to charge for the time spent drawing up the papers. The various uses of the term ‘mortgage points’ clearly are among the most confusing aspects of getting a mortgage. ‘If you talk to three different lenders about what the interest rate will be and what the loan will cost, you will get three different amounts and three different uses of the word mortgage points,’ Duncan says. ‘This is why it is so important to talk to more than one lender and to tell each lender what the others are offering.’ When you are mortgage-hunting, let the lender know what interest rates the other lenders are charging, the mortgage points in terms of prepaid interest, and how much the mortgage points or flat-rate charges to process the loan will cost. ‘The number one consumer protection is shopping,’ Duncan says. ‘There are no foolproof methods, but comparison shopping is the best one going.’

He explains that another reason to know which mortgage points are prepaid interest and which are associated loan costs is because prepaid interest is tax-deductible, while loan-associated costs are not. Since mortgage interest payments are the single largest income tax deductions the average homeowner will ever have, it is important to know what is deductible. Deduct too many mortgage points, and the IRS could be calling on you. Deduct too few, and you are throwing away money. ‘From the consumer’s perspective,’ Duncan says, ‘when you buy a house, the interest-related mortgage points are a deduction in the year the mortgage points are paid. On a refinance, however, the mortgage points you pay are deductible over the expected life of the loan, not all in one year.’ So if you take out a 30-year, $100,000 loan to purchase and pay one prepaid interest mortgage point, you can deduct the full $1,000 that year. If you take out a 30-year, $100,000 refinance loan for one prepaid-interest mortgage point, however, you would be able to deduct only 1/30th of that $1,000 on your taxes every year — $33.33.

Duncan adds that some of the mortgage points associated with getting a loan also may be deducted from your taxes, depending upon the exact nature of the expense, your own personal circumstances and where you live. Check with your Pflugerville notary. Buying a home is a major and complex financial arrangement, and you should make sure you understand all the details of the process — each and every mortgage point. The last thing you want to do when you make the largest single investment of your life is miss the mortgage point(s) — any of them.





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