Dear Dr. Don,
Do you have a calculator that enables me to compare the advantages and disadvantages of the fees and interest rates for mortgages from various firms? In other words, to help me determine whether to pay fees now to get a lower interest rate.
-- Roger Rates
Dear Roger,
There are two types of points paid at closing on a mortgage: discount and origination points.
Mortgage origination points cover closing costs. They don't have anything to do with getting a lower interest rate on your mortgage.
Discount points are prepaid interest on the loan. They do lower the rate used in calculating the mortgage payment, but they are an interest expense that adds to the annual percentage rate of the loan.
Some closing costs are also used in calculating the APR, but not the actual mortgage payment.
As defined in the Bankrate glossary, a point equals 1 percent of a mortgage or other loan. One point on a $100,000 loan is equal to $1,000. In general, it only makes sense to pay discount points if you plan on being in the house, and the loan, for a long time.
Bankrate's "Mortgage point adviser" walks you through a decision process to help you determine if paying points is right for you. There's also a "Mortgage points calculator" that lets you compare two loans -- one with and one without discount points included in the mortgage.
There are income-tax effects from prepaying interest that you can discuss with your tax professional. Or, take a look at IRS Publication 936, "Home Mortgage Interest Deduction," for a detailed explanation.