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Understanding Points and Fees

Once you have decided on the mortgage type you're after, narrow your choices down by comparing interest rates, fees, and discount points.

About Points
A discount point is a fee that must be prepaid, equal to 1 percent of the principal borrowed. Banks charge points as a commission when they sell a mortgage to the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (Freddie Mac), and they simply retain the fee if they decide to keep your mortgage themselves. For this reason, the payment of points is often negotiable depending on the lender and the mortgage type and terms.

The Truth in Lending Act requires banks to include points required in their calculation of the total APR for any mortgage offered to consumers, so it's easy to find out what kind of impact points will have on your mortgage, lender by lender. Sometimes, buyers opt to pay additional points up front in order to reduce their monthly mortgage payments, especially if they intend to stay in their house for a long time, and want to build up their equity and pay off their mortgages quickly.

About Fees
Lenders may also include a number of miscellaneous fees. They may be listed under a variety of labels such as "document preparation fee", "settlement fee" or "administrative fee". You should also gain an understanding of any loan origination fee. Such fees can vary widely from lender to lender.

Keep in mind that fees are only part of the equation when selecting a mortgage. Try to look at the loan package in its entirety before deciding against a loan based on fees alone. Other features of the loan, such as a lower interest rate or easy qualification, could make a loan with high fees a worthwhile option.

Professor Jack Guttentag of the prestigious Wharton business school did a quick comparison of fees charged by each of 28 lenders advertising 30-year fixed-rate loans in his local paper one Sunday. He found that most fees ranged from relatively modest amounts up to several thousand dollars. The most expensive lender's fees were more than $2,500 greater than fees from any of the other 27 lenders.

Avoid Suprises
To avoid surprises at closing, make sure you get a detailed and complete list of all fees early in the application process. You should also ask for enough information to understand what these fees cover; you may also be paying for the same item somewhere else. Some of these costs may be paid prior to closing, but all of them will be listed on your closing statement.

A mortgage contract with a prepayment clause can enable you to make early payments that will reduce the principal you owe and add to your ownership (or equity), usually with no additional penalty or charge. Prepayment does more than increase the amount of money you've invested in your house (your ownership equity). Prepayment reduces the term of the loan and also reduces the amount that goes toward paying off interest each month. And that's money in your pocket!

You may want to insert a clause in the mortgage contract about assumability. An assumable mortgage can be a great asset, especially if you have favorable interest rates and terms. An assumable mortgage can be taken up by the buyer of your home in the event that you sell your house five years down the road, so if interest rates have risen by that time, buyers will flock to your door!

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