While you’re shopping for a mortgage loan you will come across several different mortgage options.
Regardless of how vast your knowledge base may be about the mortgage industry, odds are you’ll come across several terms that could throw you off balance, except if you’re an expert.
The key is to learn as much as you can about mortgages to keep yourself in the loop.
Even if you have an expert that is advising you about the most suitable mortgage that matches your finances and with the lowest rates, learning about mortgages on your own can help you make informed decisions.
In this article, I’m going to explain three key mortgage terms that are worth your time and perhaps your money.
- Mortgage points
- Discount points
- Lender credit
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Mortgage Terms That Are Worth Knowing About
Let’s see why these three mortgage terms are so important:
Mortgage points refers to an easy method for lenders to indicate a charge that signifies 1% of a mortgage loan sum. This shows that for each $100,000 of a mortgage loan, 1 point is equivalent to $1000.
Points are often used to determine origination fees, interest rate discounts, and lender credits. As a borrower, you can purchase points from our lender to reduce the amount of your mortgage’s interest rate.
On the other hand, points could mean lender credit or origination points and they are determined in a similar percentage-base method.
Likewise, lender credits and discount points are presented to borrowers as a means of changing the payment method of a mortgage.
You can buy discount points in cash at the start of the period of your mortgage term to reduce your interest rates and perhaps save money throughout the loan’s lifespan.
Distinctly, lender credits refer to points you can use as a borrower to reduce a mortgage’s upfront cost. Lender credits are usually included in the loan balance and you’ll have to pay them off throughout the loan’s lifespan.
Although buying discount points and lender credits are not mandatory, payment for origination points is necessary for many mortgages and that doesn’t change the mortgage payment’s method.
In fact, origination points are used to indicate the cost you have to pay for a mortgage origination – a service charge that is asked for as a result of helping you to process your loan application.
If you’re a first time home buyer, you should read about the key things to consider before buying your first home here.
As a borrower, discount points will allow you to pay additional upfront cash in return for a reduced interest rate and a less expensive monthly payments. If you buy one discount point, it will reduce your interest rate by .25 percent.
For instance, if you purchase a point from your lender on a $200, 000 mortgage that has an interest rate of 4.5, you will be required to make a payment of additional $20,000 upfront to reduce the interest rate to 4.25%.
This is otherwise known as buying down the interest rate. Buying discount points can reduce the entire cost of your mortgage. The best part is that discount points qualify for tax deduction.
However, one of the key disadvantage of buying discount points is that they will increase the upfront costs of securing a mortgage.
If you’re a homebuyer who is already having a hard time paying your down payment, discount points could turn out to be a huge burden on your shoulder.
If you have an adjustable rate mortgage, (ARM), which fixed rates only apply for just for some years, discount points may only be relevant only for the lifespan of the fixed rates.
However, for many ARMs, lenders may not initiate the discount as soon as the ARM’s interest rate starts to change with the market.
One of the most effective methods to decipher the benefits of buying discount points is to work out the break-even point.
The calculation will indicate the precise point at which purchasing the interest starts becoming beneficial.
If you make up your mind to refinance or sell your property prior to the break-even point, then you shouldn’t bother about buying discount points.
In many cases, purchasing points is only worth it if you intend to stay in the house until you surpass the break-even points and enjoy the discounted benefits that accompany it.
Are you a first time home buyer? Learn more about types of mortgages here.
The functions of lenders credit are in contrast to discount points. Succinctly, lender credits are utilized to reduce a mortgage’s closing cost in return for a higher interest rate over the period of a loan’s lifespan.
Basically, lenders credit is additional loan money, offered by the lender upfront. It allows some of the actual costs of securing a loan to be postponed until a future date.
The question is “how is this credit useful?”
Borrowers who had to empty their savings to make a down payment and are not interested in paying more in upfront cash benefit from this credit.
Lenders usually request for several different closing costs, as such lessening the actual cash payment can take some financial burden off your shoulder.
Nonetheless, it is noteworthy to mention that purchasing lender credits will raise the amount of money you’re required to pay monthly.
Here’s a simple guide about how to get pre-approved for a mortgage.
Typically, mortgage lenders request for loan origination fees in return for the service of administering a loan application and securing the loan.
Based on some conditions contained in the IRS Publication 530, these fees are tax deductible.
Your lender can deduct your origination point fee either in the same year that you’re given a loan or during the lifespan of the loan – based on how you make payments.
Many lenders request for origination fees that amount to one mortgage point or one percent of the entire loan point.
Absolutely distinct from lender credits and discount points, which are not mandatory purchases, origination fees are not optional charges, they are mandatory fees for securing a loan.
According to the government, lenders should indicate these costs on the Loan Estimate and Closing Disclosure forms which lenders offer at the starting and ending of a mortgage application process, accordingly.
Legally, lenders cannot increase the origination cost mentioned on the Loan Estimate. However, if you’re a borrower with a good credit, you can figure out how to negotiate a reduced fee.