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Evaluating Mortgages

What are points?

Points are up-front interest, and points cost you money. Lenders charge points as a way of being paid for the work and expense of processing and approving your mortgage.

Lenders quote points as a percentage of the mortgage amount and require you to pay them at the time that you close on your home purchase and begin the lengthy process of repaying your loan. One point is equal to 1 percent of the amount that you're borrowing. For example, if a lender says that the loan being proposed to you has two points, that simply means that you must pay 2 percent of the loan amount as points. On a $120,000 loan, for example, two points cost you $2,400.

What is a prepayment penalty?

Some mortgages come with a provision that penalizes you for paying off the loan balance faster. Such penalties can amount to as much as several percentage points of the amount of the mortgage balance that is paid off early.

When you pay off a mortgage early because you sold the property or because you want to refinance the loan to take advantage of lower interest rates, some lenders won't enforce their loan's prepayment penalties as long as they get to make the new mortgage. Even so, your hands are tied financially unless you go through the same lender.

Many states place limits on the duration and amount of prepayment penalty that lenders may charge for mortgages made on owner-occupied residential property. The only way to know whether a loan has a prepayment penalty is to ask and to carefully review the federal truth-in-lending disclosure and the promissory note the mortgage lender provides you. Many so-called 'no points' loans have prepayment penalties.

What is the main advantage of a 30-year mortgage over a 15-year mortgage?

The main advantage that a 30-year mortgage has over its 15-year peer is that it has lower monthly payments that free up more of your monthly income for other purposes. A 30-year mortgage has lower monthly payments because you have a longer time period to repay it (which translates into more payments). A fixed-rate 30-year mortgage with an interest rate of 7 percent, for example, has payments that are approximately 25 percent lower than those on a comparable 15-year mortgage.

What if I can afford the higher payments that a 15-year mortgage requires? Should I take it?

Not necessarily. What if, instead of making large payments on the 15-year mortgage, you make smaller payments on a 30-year mortgage and put that extra money to productive use?

A terrific potential use for that extra money is to contribute it to a tax-deductible retirement account that you have access to. Contributions that you add to employer-based 401(k) not only give you an immediate reduction in taxes but also enable your investment to compound, tax-deferred, over the years ahead.

If you have exhausted your options for contributing to all the retirement accounts that you can, and if you find it challenging to save money anyway, the 15-year mortgage may offer you a good forced-savings program.

When you elect to take a 30-year mortgage, you retain the flexibility to pay it off faster if you so choose. Just be sure to avoid those mortgages that have a prepayment penalty. Constraining yourself with the 15-year mortgage's higher monthly payments does carry a risk. Should you fall on tough financial times, you may not be able to meet the required mortgage payments.

Not all mortgages come in just 15 and 30-year varieties. You may run across some 20 and 40-year versions, but that won't change the issues.

Do all mortgages just come in 15 and 30-year varieties?

Not all mortgages come in just 15 and 30-year varieties. You may run across some 20 and 40-year versions, but that won't change the issues.

Should I setup electronic mortgage payments?

Mortgage lenders want to be paid and to be paid on time. And you should want to pay them on time. Late payments can cost you dearly -- many mortgages have stipulations for penalties equal to 5 percent of the amount of the mortgage payment if your payment is late. If your payment is one whole month late, a 5 percent penalty works out to an annualized interest rate in excess of 60 percent! Even being one day late can trigger this penalty. Late charges also show up on your credit report.

Sign up for your mortgage lender's automatic-payment service to have your mortgage payment sent electronically from your checking account to the lender on the same day each month.