What's in this article?
Interest rates came off historic lows during the pandemic and are now at 10+ year highs.
Anything that could cut your monthly payment while purchasing a home should be given a second look.
Some homeowners buy mortgage points, also called “discount points,” in order to reduce their interest, negotiate a fair price, and get the best mortgage rates. So, what exactly are mortgage points?
We’ll look at discount points and how they can reduce your mortgage payment. Keep in mind that when lenders give rates, they might also add a rate based on the number of points purchased. Read on to find out when to consider or avoid using mortgage points.
What are mortgage points?
Mortgage points, also known as discount points, are payments made directly to the lender in exchange for a cheaper interest rate. This is also known as “buying the rate down.”
You pay more money upfront in exchange for a reduced overall interest rate loan. Buying points to lower your monthly mortgage only makes sense if you pick a fixed-rate mortgage and intend to keep the house until the point where you recoup the money you paid.
The break-even period is the amount of time required to make back the cost of purchasing points. One mortgage point is equal to one percent of the loan amount.
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How to calculate mortgage points
Points are calculated as a percent of your entire loan amount. One point equals 1% of your mortgage loan. If your lender suggests buying points for a reduced rate, you must consider whether this extra expense is justifiable.
For instance, if you are considering a $200,000 loan, one point equals $2,000 or 1% of the loan’s value. That sum can be calculated by multiplying 1% by $200,000. You must profit by more than $2,000 in order for that payment to make sense.
The quantity of points isn’t usually a round number, and your lender might provide you with a few choices. Depending on what your lender offers, you might be able to pay 1%, 0.50%, or any other amount.
Compare those quotes with other lenders to determine which loan is best.
Depending on your circumstance, buying discount points can save you some money. Here’s an example with a $400,000 loan:
|Number of points||Costs per points||Monthly Payments||Total savings on a 30-year loan|
|0 points(4.5% APR*)||$0||$2,026.74||N/A|
|1 point(4.25% APR*)||$4,000||$1,967.766||$21,232.8|
|2 point(4% APR*)||$8,000(4% APR*)||$1,909.66||$42,148.8|
Note: This is only an example. The actual rate buydown per point varies by lender and market conditions. We also didn’t account for taxes or insurance. Use this calculator to calculate how much you will need to pay.
How to calculate your break-even point
Let’s use the values mentioned earlier to walk through an example quickly.
Going from a 5.125% interest rate to a 4.75% interest rate on a $400,000 loan will save you $92 a month.
As previously stated, 1.75 points on a mortgage with a loan amount of $400,000 cost $7,000 to pay. Your breakeven threshold is approximately 76 months ($7,000/$92 equals 76.08), or roughly 6 years and 3 months if you split the upfront purchase of the points by your monthly savings.
So it is smart to pay for the points since you’ll save money if you intend to stay in your home for longer than that and pay off your loan according to the original timeline.
Are mortgage points worth it?
Purchasing mortgage points can lessen your loan’s total cost and monthly payment. It makes the most sense if you intend to live there for an extended period. The amount saved per month will probably outweigh the initial expense.
When to consider mortgage points
- To lower the interest rate on your mortgage (It’s advisable to buy mortgage points when interest rates are high)
- When you intend to live in the house long enough to recover the cost
- When you have extra money on hand for the closing
- If you’re refinancing and racking up equity in your home
When to avoid mortgage points
- You plan to sell soon or won’t stay there long enough to recoup costs.
- If you can afford to make a 20% down payment or more (A bigger down payment might lead to a reduced interest rate, less expensive or no mortgage insurance, or reduced monthly payments).
- If you don’t have the funds to purchase points. You’ll also need to pay other closing costs and a down payment. Don’t use your savings account now to later save on interest. Make additional principal payments when you have the funds available instead.
- When rates are likely to improve in the near future.
- If you intend to refinance quickly. Points are not reimbursed if you refinance.
- If you intend to repay the loan in the initial few years. The points paid will not be offset by the interest saved.
Can you pay points on a mortgage refinance?
During a mortgage refinance, mortgage points can be used in different ways.
They may even be required; a lender may ask a borrower to pay a specific amount in points at closing. Sometimes they are voluntarily made to obtain better loan terms.
Most reputable lenders will allow you to add points, particularly those offering 30-year fixed refinancing mortgages. Refinancing points can be used in several different ways.
Buy down your rate
By paying points at closing, you can “buy down” the interest rate on your home loan. For example, your interest rate might go down by 25% for every point you pay for. It’s typical to purchase 0 to 4 points. Tax deductions are available for this upfront payment, which could result in further savings for the borrower.
Many mortgage loans limit early payoffs or buyouts. You may have to incur steep penalties if you repay your loan early. Refinance points can occasionally be utilized to eliminate that penalty.
An origination fee is charged by a lender for the processing of a loan. These fees are charged up front, are a percentage of the loan amount, and are tax deductible. Make sure to consult with a tax professional to find out how points will affect your tax situation.
Let Homefinity guide you to the right decision
We understand how price can be the difference between buying the home of your dreams and just a house. That’s why at Homefinity, we are committed to guiding you to the right decision.
Contact us today to crunch the numbers and advise you on the best strategy to help you buy the home of your dreams.
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