What are points?
Points are up-front mortgage interest fees paid on a loan to reduce the
initial interest rate. For example, a one point loan will always have
a lower interest rate than a zero point loan. Therefore, paying points
is a trade off between paying money now versus paying money later.
When You Should Pay Points
Generally, you should only pay points if you plan on keeping the loan
for at least four years. Because points are prepaid interest, you need
to be sure you will keep the loan long enough to recoup these costs
through lower monthly mortgage payments. If there is a chance you may
move within a four year period or if the general interest rate market
is declining (increasing the likelihood of refinancing), you should
consider a no points or cash back loan.
The tax treatment of points depends on what the loan is being
used for. If you are purchasing a home, points are generally
deductible in the year you buy. This is true even if the seller
is paying for your points.
In a refinance transaction, points must be amortized over the
life of the loan. For example, on a 30 year loan, you can
deduct 1/30th of the points paid each year. If you refinance
for a second time, however, you can deduct the remaining
unamortized points in the year you refinance the loan.
Consult your tax advisor for more information.
Effect on APR
A common though not necessarily relevant way to measure loan
costs is the annual percentage rate or APR. The APR shows
points and costs as an interest rate equivalent spread over
the life of the loan. As shown in the figure below, fixed
rate loans are more sensitive to changes in points than
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