Pros and Cons of Buying Points on a Mortgage in 2022
What is the point of buying mortgage points?
When mortgage rates rise, borrowers scramble to find ways to get the lowest interest rate possible. One option is to pay mortgage points to “lower” your rate.
Buying a reduced rate means paying your mortgage lender an additional upfront fee, called “discount points,” to get a lower interest rate and monthly payment.
When interest rates are very low, few borrowers pay higher closing costs to get a discount. But as mortgage rates rise, borrowers are more likely to weigh the pros and cons of buying points to lower their mortgage rate.
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How the mortgage points purchase works
A mortgage point or discount point is equal to 1% of your loan amount. That’s $ 4,000 for a mortgage of $ 400,000. Essentially, you are paying to lower your interest rate. Using the example of a $ 400,000 mortgage:
- Mortgage loan of $ 400,000 at 3.25%
- One point of call costs $ 4,000 and lowers the rate by 0.25%
- This point lowers the rate from 3.25% to 3%
- Over 30 years at 3.25%, you would pay $ 226,607 in interest repayment
- Over 30 years at 3%, you would only pay $ 207,109
- Total savings: $ 19,498
The rate reduction you get per point depends on the length of your loan and market conditions. Typically, for a 30 year fixed rate loan, one point of discount gets you a lower mortgage rate of 0.125% to 0.25%.
However, the relationship between the cost of points and the reduction in the interest rate is not perfectly symmetrical. Even for the same loan.
How to buy loans with mortgage discount points
Here is an example. Suppose a national lender offers a 30-year fixed rate mortgage at 4.5% with no points. You can take 0.25% off and get 4.25% by paying half a point off.
But a rate of 4.125% (just 0.125% lower) costs an extra point. Paying more doesn’t necessarily give you a better deal.
When shopping for a mortgage with discount points, the easiest way to compare deals is to decide how much you want to spend, and then see who’s offering the lowest rate for that price.
Alternatively, you can decide what mortgage interest rate you want and see which lender charges the least for it.
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Benefits of buying mortgage points
The biggest advantage of buying points is that you get a lower rate on your mortgage, regardless of your credit score. Lower rates can save you money on both your monthly mortgage payments and total interest payments over the life of the loan.
- If your income is too low for you to qualify for the home you want, you may be eligible for a reduced interest rate and payment.
- If you have the cash on hand, or if you can get a home seller to pay rebate points for you, lowering your rate may help you qualify for your mortgage.
- Buy points can save you money over the life of the loan, but usually when you don’t sell or get mortgage refinancing for enough years to break even.
- Understand, however, that the initial cost of mortgage points can be substantial.
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How much money can you save by purchasing mortgage points?
Is purchasing points beneficial if you keep your new home for five years? You can find out by using a mortgage calculator.
Suppose it costs two points ($ 8,000) to reduce the interest rate on a 30-year, $ 400,000 fixed rate loan from 4.5% to 4.0%. Your monthly mortgage payment for principal and interest would decrease by $ 117 with the lower rate ($ 1,910 instead of $ 2,027).
After five years, with the 4.0% home loan, you will have paid $ 76,370 in interest, plus $ 8,000 in mortgage points, for a total of $ 84,370. You will have reduced your principal balance by $ 38,210.
With the 4.5% loan, you will have paid $ 86,236 in interest. You will have reduced your principal balance by only $ 35,368.
In this case, it will cost you $ 1,888 less over five years if you pay the discount points. But that’s not all. You will have reduced your balance by an additional $ 2,842. So your total savings over five years is $ 4,730.
Another advantage of paying mortgage points is that since they represent prepaid interest, they are generally tax deductible.
Disadvantages of points of purchase
While lower monthly payments and potential savings over the life of the loan are obvious benefits of buying mortgage points, there are some reasons why it might be better not to buy points.
First, paying for one or more points locks in your money. If you make a down payment of less than 20% or have less than 20% of your home equity when refinancing, you will likely need to pay for private mortgage insurance (PMI) if you have a conventional loan.
Ask a lender or mortgage broker to compare the impact of a larger down payment on reducing or avoiding PMI.
Additionally, the sample calculation does not take into account that you might have better uses for that money – for example, paying off high interest credit card debt, making investments, or saving for future home renovations.
You may also want to use this money to invest in assets other than real estate for diversification purposes, to increase a college tuition fund, or to inflate your retirement account.
The money you pay to lower your mortgage interest rate may not provide the same benefits as other investment vehicles, but for homeowners who plan to stay put for the long term, a higher interest rate. low might be a good idea.
Mortgage Discount Points FAQs
Paying mortgage discount points on an adjustable rate mortgage (ARM) only provides a discount during the initial fixed rate period of the ARM. With a 0.25% discount rate, it typically takes around 4-6 years of homeownership to break even with these loan terms. Therefore, your fixed rate open period should be longer than 4-6 years for real savings.
The points of call and the points of departure are different. Origination points refer to the origination fees that a borrower pays to their mortgage lender for the processing and underwriting of a home loan. While rebate points are an upfront fee that buyers pay at closing to lower their mortgage interest rate.
One point costs 1% of your loan amount, or $ 1,000 for every $ 100,000. For example, if your mortgage is $ 400,000, then a point of discount would be $ 4,000. Additionally, many mortgage lenders will allow homebuyers to purchase fractional points. On a $ 4,000,000 home loan, half a point would cost $ 2,000.
What are the interest rates today?
Current mortgage rates depend, in part, on what buyers are willing to pay for a home loan. In general, the higher interest rates go to those who pay less.
And remember, the lowest rate isn’t always the best deal. A good loan officer should be able to help you sort through your home buying options and choose the cheapest program for your needs.
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