Mortgage points are a way to lock in a lower interest rate and pay less on your loan over time. Use our guide to understand how points are calculated and gauge whether buying mortgage points makes sense for your situation.
Whether you’re looking to purchase or refinance, understanding mortgage points can give you a better idea of the relationship between closing costs and your interest rate.
What Are Mortgage Points, And How Do They Work?
A mortgage point – sometimes called a discount point – is a fee you pay to lower your interest rate on your home purchase or refinance. One discount point costs 1% of your loan amount. For example, if you take out a mortgage for $100,000, one point will cost you $1,000. For a $200,000 loan, a point costs $2,000.
Points are paid for at closing. Your lender will calculate the cost of any points you agree to purchase and add those costs to your other closing costs.
For each discount point you buy, your interest rate will be reduced by a set percentage point. The per-point discount you’ll receive varies by lender, but you can generally expect to get a .25% interest rate reduction for each point you buy. Most lenders cap the number of points you can buy, and most allow you to purchase a fraction of a point. Generally, points can be purchased in increments down to eighths, or 0.125%.
For example, let’s say you take out a $200,000 30-year fixed-rate mortgage at 4.125%. Your lender offers you an interest rate of 3.75% if you purchase 1.75 mortgage points. On a $200,000 loan, each point is equal to $2,000, which means that 1.75 points is equal to $3,500.
If you choose not to buy mortgage points, your interest rate will remain at 4.125%. Over 30 years, without paying down the loan early, the cost of the loan, with interest, is $348,947.70.
However, if you opt for the 1.75-point discount, you end up paying $333,443.38 over the life of the loan. This means that paying points saved you $15,504.32 over the course of your 30-year mortgage.
The Benefits Of Mortgage Points
People buy points to lower their interest rate and save on the overall cost of the loan.
Points can increase your closing costs by thousands of dollars, but the large upfront cost might be worth it if you stay in the home long enough to see savings from the reduced interest rate. Paying an extra $2,000 upfront could mean tens of thousands of dollars in savings over the course of your mortgage. However, if you plan to sell your home or refinance before your break even, paying points might not be worth it.
Points can also be a way to get a lower monthly payment. If your monthly mortgage payment puts too much of a strain on your budget, mortgage points could be a way to save. A lower interest rate equals lower monthly payments.
You also may save on taxes if you decide to purchase mortgage points. Since mortgage interest is tax deductible and points are considered prepaid mortgage interest, you may be able to deduct the cost of the points on your taxes. To understand the deductions you may be eligible for, check out the IRS rules on mortgage point benefits and speak with a qualified tax expert.
Should You Buy Mortgage Points?
Lower interest rates are always great, but mortgage points might not be the right solution for every borrower. Here are some things to consider when you’re determining whether to buy points.
When To Buy Mortgage Points
Buying mortgage points might make sense if any of the following situations apply to you:
You want to stay in your home for a long time. The longer you stay in your home, the more it makes sense to invest in mortgage points. If you’re sure you’ll have the same mortgage for the long haul, mortgage points can lessen the overall cost of the loan. The longer you stick with the same loan, the more money you’ll save with discount points.
You’ve determined when the break-even point is. Do some math to figure out when the upfront cost of the points will be eclipsed by the lower mortgage payments. If the timing is right and you know you won’t move or refinance before you hit the break-even point, you should consider buying mortgage points.
How do you calculate that break-even point? Let’s run through a quick example using the numbers referenced earlier.
If you have $200,000 loan amount, going from a 4.125% interest rate to a 3.75% interest rate saves you $43.07 per month. As mentioned earlier, the cost of 1.75 points on a $200,000 loan amount is $3,500. If you divide the upfront cost of the points by your monthly savings, you’ll find that your breakeven point is 82 months ($3,500/$43.07 equals 81.3). If you plan to stay in your house for longer than 6 years, 10 months and pay off your loan according to the original schedule, it makes sense to buy the points because you’ll save money in the long run.
When Not To Buy Mortgage Points
Mortgage points don’t make sense for everyone. Here are some reasons not to buy them:
You don’t plan to stay in your home for long. If you’re a wandering soul who loves to move from place to place every few years, you won’t get much benefit out of mortgage points. Points are a long-term strategy to pay less interest over time. It takes a few years for the money you save on interest to override the amount you spend to buy the points. If you know you’ll want to move at any point in the near future, mortgage points aren’t worth the cost.
You plan to pay extra on your mortgage payments. Mortgage points will only benefit you if you pay on your loan for a long time. If you have the means to pay off your loan quickly, you might not end up saving much money.
You don’t have the money to buy points. It’s not worth emptying your savings account to save on interest down the line. Instead, you could save on interest in the long run by putting extra money toward your principal when you have the cash.
Your down payment would suffer. It’s usually better to apply extra cash to your down payment than to points. A larger down payment could mean a lower interest rate, cheaper mortgage insurance (or none at all) or lower payments. Mortgage discount points don’t come with all of these benefits.
Final Thoughts On Mortgage Points
Though mortgage points may be right for some borrowers, they don’t make financial sense for everyone. To determine whether you can save with discount points, you have to crunch the numbers. Sit down and assess your budget, down payment and future plans before you close. Determine your break-even point and your likelihood of staying in the home to understand if discount points will save you money in the long run when buying or refinancing a home.
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