Mortgage points can be helpful for home buyers. But should you buy it? Is it a smart move? Read this article to learn more
Because buying a house will likely be one of the largest purchases in your life, it is understandable that you will want to save money where possible. Beyond finding your dream home, negotiating the best price, and pursuing the best mortgage rates, there is another approach: buying mortgage points.
as part of our client education series, we invite our regular mortgage professional readers to pass this along to who have questions about mortgage points. In addition, if you have a professional opinion to add, please use our comment section at the bottom.
Also known as discount points and mortgage buydowns, mortgage points are fees that you, the homebuyer, pay directly to your lender or bank in exchange for a reduced interest rate. (The process itself is also sometimes referred to as buying down the rate.)
Basically, you pay some of the interest on your mortgage upfront to lower your interest rate over the life of the loan. Every point you purchase costs 1% of the total amount of your loan.
Here is a basic formula for mortgage points:
1 point = 1% of your mortgage
That could equate to $3,000 for every $300,000, for instance.
Purchasing points to lower the monthly payments you make on your mortgage could be a good idea if you choose a fixed-rate mortgage and want to own the property even following the break-even period. The break-even period is how long it will take to recoup the cost of purchasing points.
For every mortgage point you purchase, your interest rate will then be reduced by a certain percentage point. While this percentage varies depending on the lender, a reduction of 0.25% in your interest rate per mortgage point purchased is common.
While the most points you can buy is usually capped by lenders, you can buy as little as 0.125% in interest rate reduction.
How much you may potentially save
Let’s look at an example:
- You take out a $200,000, 30-year fixed-rate mortgage at 5.125%
- If you buy 1.75 mortgage points, your lender will offer you an interest rate of 4.75%
- Every point will cost you $2,000 (1% on a $200,000 mortgage)
- You will pay $3,500 for those 1.75 mortgage points
In this scenario, you decide to forgo purchasing any mortgage points:
- Your interest rate remains 5.125%
- After 30 years, and not repaying the loan early, you will pay roughly $392,000 (includes interest)
And in this second scenario, you decide to purchase the 1.75 mortgage points (costing $3,500):
- You wind up paying roughly $376,000 over the life of your loan
- Savings: over the 30-year mortgage, you saved just over $16,000
While the figures used in these examples make a few assumptions, it is important to know the variables you need to consider when purchasing mortgage points. Some of these variables include:
- The mortgage lender
- The loan type
- The loan term
- The loan amount
- The number of mortgage points purchased
Whether it is smart to buy mortgage points to lower your interest rate depends on your financial situation. In other words, it is not always the best option for every homebuyer.
When to purchase mortgage points
Here are a couple of instances when it would be smart to buy mortgage points:
- You plan to remain in the home in the long term
- You have figured out when the break-even point is
Why are these favourable instances to purchase mortgage points? Here is a closer look:
1: You plan to remain in the home in the long term
If you stay in your house for a longer period, you will increase the chances of benefitting from a lower mortgage rate. In that case, it would make sense to purchase points. This is especially true if you are certain to have the same mortgage for a long time. The longer you have the same loan, the more you will benefit from mortgage points, i.e., the more money you will save.
2: You have figured out when the break-even point is
You can calculate when the up-front cost of the mortgage points will be surpassed by the lower mortgage payments. You will want to think about buying points if you know you will not move or refinance prior to hitting the break-even point.
How do you calculate your break-even point? Here is an example using some of the same figures above:
You go from a 5.125% interest rate on a $200,000 mortgage to a 4.75% interest rate, saving $46/month. Lowering your interest rate by 1.75 points on the $200,000 mortgage cost about $3,500. If you divide the up-front cost of the mortgage points ($3,500) by your savings ($46), you will get your break-even point (76 months).
The formula might look like this:
Up-front cost/savings per month=break-even point.
Essentially, it will make sense for you to purchase mortgage points if you plan on residing in the home for longer than 76 months.
When not to purchase mortgage points
Some reasons why it might not make sense for you to purchase mortgage points include:
- You plan on moving
- You want to pay more on mortgage payments
- You can’t afford it
- You would be sacrificing on your down payment
- Refinancing soon
Here is a more in-depth look:
1: You plan on moving
Because mortgage points are more of a long-term strategy to pay lowered interest, you will not benefit from them if you plan to move in the short term. As indicated by the break-even point above, it will take some time for the money you spent on the points to surpass your monthly savings. (76 months, in the above example.) If you plan on moving soon, mortgage points may not be worth the cost.
2: You want to pay more on mortgage payments
The logic here is like the logic of the above example: you need to have the mortgage for the long term in order to benefit from it. In other words, if you have the money to pay off your mortgage faster, you will not end up saving enough for it to be worth it. Mortgage points are all about the long goal.
3: You can’t afford it
Spending everything you’ve got to potentially save money in the distant future may be a bad idea. The better move would be to put any extra money you do have toward the principal. In that case, you would still save on interest.
4: You would be sacrificing on your down payment
A general rule is that it is probably better to spend any extra money you have on a down payment instead of mortgage points. Doing so may mean lower interest rates, lower payments, or lower mortgage insurance, if any. Mortgage points do not carry with them all these perks.
5: Refinancing soon
Purchasing mortgage points may seem like a great idea when interest rates are ballooning. However, if you want to refinance sooner than later, you will be forced to pay origination points and discount points again for the new mortgage, meaning you will essentially pay the same costs twice.
In the perfect world, you will pay for mortgage points to lower your interest rate and therefore save on the overall cost of your mortgage. Among the benefits of mortgage points are:
- Saving money
- Lower monthly payments
- Save on your taxes
Here is a closer look at each:
1: Saving money
This is the major reason for, and benefit of, purchasing mortgage points. While they can add thousands of dollars to your closing costs, the upfront costs of mortgage points may be worth it—if you remain in the house long enough for the reduced interest rate to earn you savings.
As seen, paying a few extra thousand dollars upfront may mean saving tens of thousands of dollars over the life of the loan. Paying for points may not save you money, however, if you plan to refinance or sell your home prior to breaking even.
2: Lower monthly payments
Because mortgage points are a way to lower your interest rate, you will be forced to pay less in interest every month. Therefore, your monthly payments will drop.
3: Save on your taxes
Remember: Interest on your mortgage is tax-deductible. Since mortgage points are technically pre-paid mortgage interest, you will likely be able to deduct the cost of those mortgage points on your taxes. Before making any assumptions on this benefit, however, it is important to verify your situation with a qualified tax expert.
As mentioned, mortgage discount points are essentially a form of pre-paid interest that help you lower the interest rate on your loan. Generally, your interest rate will be reduced by 0.25% per each mortgage discount point you purchase.
You can lower your monthly payment by lowering the interest rate on your mortgage. Always remember that this also means an up-front payment. And the longer you want to live in your house, the more you will benefit from purchasing points.
Mortgage origination points are another kind of mortgage points, but are fees paid to the lenders to originate, review and process the mortgage. Generally, origination points cost 1% of the overall loan. For example, you would have to pay just over $4,000 on a $250,000 mortgage if the lender charged 1.5 origination points.
The major difference between origination points and mortgage discount points is they don’t directly lower the loan’s interest rate. Occasionally, lenders will let you get a mortgage with little or no origination points or closing costs. Compensation for that, however, comes in the form of higher interest rates or other fees.
The final point to bring up here is that mortgage points are a way to get around the interest rate hikes that many are facing now. If your mortgage interest rate is going up a considerable amount, it may be worth looking at using mortgage points to buy down your interest rate.
Have experience with mortgage points? Let us know in the comments section below.