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Waiting for a 1% rate reduction to refinance your mortgage? Take a look at how much cash you can save by paying points for refinancing.
Paying some upfront costs to save money, in the long run, is nothing new. But this same concept is now available for home loans and mortgage refinancing—which could be an excellent opportunity for your long-term financial planning.
But is paying points for refinancing a good idea? We’ll break down everything you should know about mortgage points and whether they make sense for your home and future.
How do mortgage discount points work?
Mortgage points are a feature that some lenders offer to lower your interest rate in exchange for a percentage of your mortgage upfront. (The flipside to this offer would be “lender credits,” which can be used to reduce your closing costs by opting for a higher interest rate.)
Points, or similar features, have been employed in the mortgage industry for a long time. Some call them “discount points,” and some lenders use this term to refer to any upfront fee calculated as a portion of the loan.
When considering paying points, it is important to ask lenders to clarify its effect on your interest rate, if any.
What is the advantage of points?
The big incentive for paying points is that they are a tradeoff between the initial costs and what you will pay each month.
Paying points will cost more at closing, but you will gain a lower interest rate and less overall expense over the long term.
This option is ideal for somebody who knows they will have the loan for an extended period.
How are points calculated?
The points are calculated based on the loan amount; one point is equivalent to one percent of the loan.
For example, on a $100,000 loan, one point would be $1,000; two points would be $2,000, and so on.
The amounts of points can also be factional values, such as 1.375 points ($1,375), 0.5 points ($500), or even 0.125 points ($125). This fee is paid during the closing of the mortgage and is included in the closing costs.
A lower interest rate is possible if you pay points with a loan from the same lender.
For example, if you’re looking at two mortgages with the same loan term, loan type, down payment amount, etc., but one with one point and one with zero points, the one with the point should have a lower rate. If you opt for a loan with two points, the interest rate should be lower than the one with one point.
Legally, the points listed on the loan estimate and closing disclosure on page 2, Section A must be associated with a reduced interest rate.
The degree to which your interest rate goes down will depend on the lender, the loan, and how the mortgage market is doing. In some cases, paying for a point can bring about a significant lowering of the rate.
Other times, however, the reduction for each point paid may be a bit more modest. Again, it depends on the particular lender, the loan, and the market circumstances.
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How paying points for refinancing can work for you
The “trick” to paying points for refinancing is to calculate when you have recouped the initial cost for your points. Let’s look at an example of what we mean
Comparing points to no points
Let’s say you choose to refinance your mortgage balance of $360,000 into a 30-year fixed-rate conventional mortgage with a proposed interest rate of 3.5%. No points are involved for this refinancing.
Therefore, your monthly payment without points would be $1616.56, depending on LTV.
The same example, this time with points
However, if you were to pay two points (2%) on the loan totaling $7,200, the interest rate could decrease to 3%.
As a result, the new monthly payment would be $1517.77, with a savings of $98.79 per month.
To figure out when you would recuperate the cost of paying for your points, divide the expense of the points by the month-to-month reserve funds amount ($7,200 / $98.79).
That results in 72.9 months or a little over six years when you’ve paid yourself back and are now saving money for the remainder of your mortgage. Each year beyond the break-even point, you would save $1,185.48 for each anniversary.
In the above example, if the person planned to stay in their mortgage for at least an additional six years past refinancing, paying points for refinancing makes sense.
However, if they intended to move within the next five years, then the use of points here would end up being a loss.
According to the latest data, the typical homeowner will stay in their home for just over 12 years. That’s just an average, of course, and there can be many reasons for staying in the same home or moving on. Most of this will depend on your personal circumstances.
Therefore, a person looking to refinance their mortgage after three or four years has greater odds of making full use of points. If you are confident that you’ll be staying in your home for a long time, then points can be a serious money-saving option.
Affordability and mortgage calculators
Utilizing a good mortgage calculator or an affordability calculator can help simplify the process and determine if paying points for refinancing is the right plan.
Getting to the point of points
If you have the cash available and can afford it, buying points for your mortgage refinance when interest rates have gone down can be a sound investment.
So long as you plan to stay in the house for a long enough time to (at least) break even, paying points for refinancing can work.
If you’re ready to talk about refinancing your mortgage, reach out to one of our loan officers.
If you’ve got more questions—whether it’s about refinancing, using points, or any other aspect of your mortgage—we’ve also got you covered there.
Connect with any of the mortgage specialists at Homefinity, and let’s see if we can make your mortgage work better for you.