Mortgage points: what are they and should you buy them?
Purchasing mortgage points from your lender can lower your interest rate and make your monthly mortgage payments more affordable. If you’re considering buying or refinancing a home, Mortgage Points could save you tens of thousands of dollars over the life of the loan.
In this article, we will explain what Mortgage Points are and discuss the pros and cons of buying Mortgage Points.
What does buying points in a mortgage mean?
Mortgage points, also known as discount points, are upfront fees a borrower pays their mortgage lender to reduce the interest rate on their loan.
Borrowers can lock in a lower interest rate on a purchase or refinance loan and pay less on their mortgage over time. This may make more sense for borrowers who plan to stay in their homes for a long time.
How much is a point on a mortgage?
A point usually costs 1% of your loan amount and lowers your mortgage interest rate by approximately 0.25%. For example, on a $100,000 loan, one point would cost $1,000. Mortgage points also don’t have to be round numbers – they can also be fractions of a point.
The reduction of each point in your mortgage interest rate varies by lender. It also depends on the type of loan product as well as the current interest rate environment. That’s why it pays to shop around with a few lenders and compare quotes.
You can also buy discount points for an adjustable rate mortgage (ARM), which works the same way as a fixed rate mortgage. However, most ARMs adjust after five or seven years.
Mortgage points are paid at closing and according to Consumer creditthey are listed on your loan estimate and final disclosure on page 2, section A. By law, items listed on these documents must be tied to a reduced interest rate.
Advantages and disadvantages of buying points on a mortgage
Advantages of buying mortgage points
The biggest benefit of buying mortgage points is to lower the interest rate on your loan, regardless of your credit rating. This saves you money not only on your monthly mortgage payments, but also on total interest payments.
Buying down your rate also lowers the total cost of the home. Paying an extra $3,000 up front could save you thousands more over the life of the mortgage.
Mortgage points are also tax deductible. The IRS considers mortgage points as prepaid interest, which may be deductible as mortgage interest if you itemize the deductions. If you deduct all interest on your mortgage, you may be able to deduct all points.
Calculate how much you can save on your mortgage payments with Total Mortgage.
Disadvantages of Buying Mortgage Points
Buying mortgage points is not recommended for everyone. If you don’t have extra cash reserves, paying mortgage points on top of your closing costs and down payment could drain your savings.
If you’re buying a home and betting less than 20% on a conventional loan, the added expense of private mortgage insurance (PMI) may not make much sense financially. It may be best to put these funds towards your down payment.
It may also take some time to break even, which is the time it takes for the monthly savings to pay off the points.
For example, let’s say you purchased 3 mortgage points for $9,000 on a $300,000 home loan financed over 30 years. This lowered your interest rate from 3.5% to 2.75% and saved you $122 per month. However, your break-even point is just over six years, and if you move or refinance before then, you may not recoup that initial cost.
Also, interest rates fluctuate. If rates drop after purchasing mortgage points, the value of the points would be essentially worthless.
Mortgage Points vs Lender Credits
You may also encounter lender loans, which are similar to mortgage loans but in reverse. Your lender may offer a higher interest rate in exchange for additional funds to offset your closing costs. Credits from lenders mean you pay less upfront, but pay more interest over time.
Lender Credits are also calculated the same way as Mortgage Points, but may appear as negative points on the Lender Credits line on Page 2, Section J of your Loan Estimate or Closing Statement.
Should You Buy Mortgage Points?
Although mortgage points can potentially save you money in the long run, they are not for everyone and it could take between five and 10 years to recoup the cost of the points.
Here are a few cases where buying Mortgage Points may be worthwhile:
- You have extra money to deposit without depleting your savings
- You plan to live in your home for a long time
- Your credit score does not qualify you for the lowest possible rate
- You need to lower your interest rate to make your monthly mortgage payments more affordable
Here are some reasons why you should not buy mortgage points:
- You plan to sell your property in a few years
- You will pay extra on your mortgage payments
- You don’t have the money to buy mortgage points
- This would reduce the amount of your deposit
If you decide to allocate additional funds to your down payment or purchase mortgage points, a larger down payment generally has more advantages than mortgage points.
A larger down payment can get you a better interest rate, a cheaper (or none) PMI, or lower mortgage payments.
Build your perfect mortgage with Total Mortgage
Mortgage Points can potentially save you money on your mortgage, but the monthly savings will depend on the interest rate, the amount you borrow, and the term of the loan. However, mortgage points may not be the best financial solution for your situation.
The right mortgage can save you thousands of dollars. Get a free quote from Total Mortgage for buying a home, refinancing or a home equity loan.