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Mortgage 101 – The truth about buying down your interest rate

Buying down your interest rate is also known as “discount points.” In this topic, I will discuss what a discount point is, an example of what it does and how to do the math to see if it makes sense for you.

Discount points lower your interest rate and payment for an upfront cost. The cost of one discount point is 1% of the loan amount and this will generally lower your interest rate about .25%. You can buy down the rate as much as two discount points on most mortgages.

Example:
Option 1 – $200,000 @ 4.25% for 30 years = $984
Option 2 – $202,000 @ 4.00% for 30 years = $964

Option 1 is with no discount points while option 2 is buying 1 discount point for a cost of $2,000. Option 2 saves you $20 more per month. The cost of the $2,000 upfront cost divided by the savings of $20 will take 100 payments or 8.3 years to recoup. However, if this mortgage is kept for the duration, the $2,000 upfront investment will save you $7,020 over the life of the loan.

After my research, the only time buying down an interest rate makes sense is if you plan on keeping the loan past the time it takes to recoup the additional cost. If you are considering buying down the interest rate, take the monthly savings divided by the cost to see how many months it will take you to surpass the break even point.

Discount points can be tax deductible as well as interest. Consult your tax advisor to maximize this deduction.

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-Charles W.

How much impact $1 can have on your mortgage?

Do you know how much your total mortgage costs? Did you know you could easily reduce that amount?

Let’s look at a typical mortgage, According to Capital Economics analysts the average American mortgage in 2012 was $235,000 while most people take a 30 years mortgage. The national average of 30 years fixed rate mortgage is currently 4.13%.

Under those conditions, a person will be paying $1,139.61 per month for the next 360 months. That’s assuming they make the minimum payments on that mortgage over the entire term. They end up paying a total of $175,259.60 in interest over the course of the loan.

What if a person adds just $1 as an extra payment each month for the entire loan? Each month, they pay $1,140.61. Will that make a difference? Well, the final payment drops to $429.99. By putting in just $1 extra each payment you save $710.62 on that last payment.

What if a person adds just $10 as an extra payment each month for the entire loan? Each month, the total payment is $1,149.61. What does that look like?
In that case, you don’t even need to make your last five payments, and the payment before that is only $1006.02. Over the course of the loan, you pay in $3,600 extra, but you end up with $5,831.64 in payments you don’t have to make at the end of the loan.

This about it this way, every dollar you pay extra on your mortgage effectively “earns” interest at a rate equal to your mortgage interest rate for the rest of your mortgage. This is a great saving plan and more than that it is TAX FREE!!!

Yes, you heard it right, if you pay $1 extra on that first payment, your dollar will earn a 4.13% return tax-free over the next twenty-nine years and twelve months. (You receive that return in the form of having the home paid off earlier than you otherwise would or if you sell the house before the mortgage is finished.) That’s a better return than your savings account will give you right now. It’s better than inflation right now, which is below 3% by most calculations. You could get a better return in the stock market over that period, but the stock market also causes risk and it also has tax implications.

The question you really have to ask yourself is will you miss that extra dollar or that extra five dollars? What would you do with it that would really make an impact in your life?

If you could live with $1 or $10 less every month, it makes sense to simply add it to your mortgage payment. It earns a steady and safe return over the long haul.
It doesn’t take much to add up to a big difference as long as you keep doing that little thing regularly.

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My wife and I originally came in just to lower our Mortgage payments. We never dreamed up that we could payoff our mortgage, our debt and be completely debt free just under 10 yrs. That is amazing and I will be sending you many referrals.

Your friend,
John Turnberry

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