In this article
- Crucial Things To Know About Buying Mortgage Points
- Mortgage Points: What Are They?
- How do they work?
- Which Is Better? Banks vs. Online Mortgage Lenders
- What Are the Benefits and Drawbacks of Buying Mortgage Points?
- Benefits of Purchasing Mortgage Points
- Drawbacks of Buying Mortgage Points
- Increasing Your Down Payment May Be More Advantageous
- Should You Buy Mortgage Points?
- When Is Refinancing a Mortgage Worth It?
- When Do You Reach The Break-even Point?
- What Percentage of Your Monthly Payment Can You Reduce?
- How Discount Points Affect a $400,000 30-Year Fixed-Rate Mortgage
- Mortgage Points: Frequently Asked Questions (FAQs)
- Mortgage Points: The Bottom Line
Desperate times call for desperate measures. It’s, therefore, no surprise that as mortgage rates rise, borrowers scurry to find strategies to get the lowest possible interest rate.
One of these strategies is using mortgage points to “buy down” your rate. Discount points are extra upfront fees to your mortgage lender, paid for the sole purpose of reducing your interest rate and monthly payment.
Because the interest rate on a mortgage is a crucial aspect that determines the size of the monthly payment and the total amount owed, paying points is a vital strategy for those who want to save.
All one needs to do is to pay an upfront charge to the lender when buying mortgage points. The discount given depends on the lender, the number of points purchased, the type of loan you have, and market conditions.
Prior to tough financial times, fewer home buyers were willing to pay extra closing fees because interest rates were extremely low. Currently, with things as they are, if paying extra closing expenses means receiving a discount, so be it!
But is it as black and white as it seems? Of course not. Read on to find out the pros and cons of buying points on a mortgage:
Crucial Things To Know About Buying Mortgage Points
• What Are Mortgage Points?
• How do they work?
• What are the benefits and drawbacks of buying mortgage points?
• How can I benefit from mortgage points?
• Are there any disadvantages of purchasing mortgage points?
• Should You Buy Mortgage Points?
• When do you reach break-even?
• What percentage of your monthly payment can you reduce?
• FAQ about Mortgage Points
• Are they tax deductible?
• How many points are you allowed to purchase?
• The Bottom Line?
Mortgage Points: What Are They?
Mortgage points are a one-time cost paid to the lender in exchange for a lower interest rate on a home loan. Because the homebuyer is required to pay more money upfront, points raise the closing expenses. At the same time, however, they lower the monthly mortgage payment and lower the total amount of interest paid throughout the loan’s term.
How do they work?
1 Mortgage point is equivalent to 1% of your total loan amount. That said, if you have a $400,000 mortgage, one point is equal to 1% of $400,000, or $4,000. Consequently, 4 points are equivalent to 4% of $400,000, or $16,000. Lenders also allow people to purchase partial points, say 0.5 points which would be 0.5 of $400,000, or $2,000.
When homebuyers pay points, lenders are compelled by the law to give them a lower interest rate. This means that a loan with 1 point from the same lender must have a cheaper rate than a loan with no points.
Nevertheless, the pricing structure between different financial institutions differs. As such, you may find that paying points with one lender may result in a higher interest rate than paying no points with another lender.
That said, the amount of your rate decrease will therefore vary depending on the lender you choose. It also depends on the type of loan you acquire, and the prevailing market conditions.
If you decide to buy points, they will appear on your loan estimate as well as the 2nd page of your closing disclosure.
Which Is Better? Banks vs. Online Mortgage Lenders
Negative mortgage points, also known as lender credits, are the reversal of points, where you minimize your closing costs by increasing your loan’s interest rate. Using the previous example, if you obtain a $4,000 lender credit — or a negative 1 point — on a $400,000 mortgage, you’ll get 1% of the loan amount to assist cover closing expenses.
In comparison to a loan with no lender credits, you’ll also be charged a greater interest rate. This implies you’ll pay more interest overall and a greater monthly mortgage payment.
What Are the Benefits and Drawbacks of Buying Mortgage Points?
Homebuyers can buy points to reduce their monthly payments and save money on interest over time. They do, however, require borrowers to pay more for closing costs. Are they worth it? Here are the pros and cons of buying mortgage points before making your decision:
Benefits of Purchasing Mortgage Points
It goes without saying that paying points comes with some benefits. Here are some of them:
• Reduced Interest Rate
If your credit score is low, you’ll almost certainly pay a higher interest rate on your loan. As such, you should strategize to improve your credit before applying for a mortgage.
This helps lower your rate. Nevertheless, if you’d like to buy a house immediately, all hope is not lost. You could still lower your rate by paying points.
• Reduced Monthly Payments
Because interest is a core component of your monthly payments, getting a lower interest rate means having a smaller monthly mortgage payment. As such, housing expenditures will occupy less space in your budget. Best part? You can save money faster or spend more on other vital aspects of your life!
• Overall, You’ll Pay Less.
By locking in a lower interest rate, you can cut the entire cost of the loan. “Borrowers who can afford to pay discount points early in a mortgage term would profit in the long run by paying a reduced monthly payment,” says David Reischer, a real estate attorney and CEO of LegalAdvice.com in New York City.
Drawbacks of Buying Mortgage Points
Purchasing mortgage points has its drawbacks as well. The following are some disadvantages of paying points.
• Larger Initial Payment.
Buying points means paying extra in advance, which means your closing expenses will be higher. Typically, the closing expenses range from 2% to 5% of the home’s buying price. As such, people who cannot comfortably afford such a large sum would find it financially incapacitating.
• You Might Not Be Able To Recoup the Cost of Points if You Move.
Mortgage points can run into thousands of dollars if paid all at once. With each monthly payment, the savings from your lower interest rate will add up over time. However, if you relocate too soon, the savings won’t be worth it. This is also true if you opt to refinance your mortgage, which would incur additional closing expenses.
Increasing Your Down Payment May Be More Advantageous
You might instead increase your down payment if you have the money to buy a lot of points. After all, if you take out a conventional loan and your down payment is less than 20% of the home’s purchase price, you’ll have to pay private mortgage insurance, which will increase your loan fees. In general, putting down a higher down payment lowers your interest rate.
Should You Buy Mortgage Points?
Purchasing points is a compromise. You’ll get a lower rate, smaller monthly payments, and pay less mortgage interest over time if you can manage the greater upfront cost.
The retail branch manager at Planet Home Lending in Shreveport, Louisiana, Alishea Pipkin says that people should consider these 3 factors when deciding whether to pay points:
1. How long do you want to maintain your loan?
2. How much money do you have set aside for closing fees?
3. How much can you afford to pay each month?
With these 3 points, you can therefore decide: Is it worthwhile to pay points on a mortgage? If you plan to pay off your mortgage early or refinance it, paying points may not be beneficial, according to Pipkin.
When Is Refinancing a Mortgage Worth It?
Borrowers typically need four to six years to recoup the cost of buying points, according to Reischer.
When Do You Reach The Break-even Point?
The break-even point is the point at which your monthly interest savings equal the initial cost of paying points. Once you’ve passed the break-even threshold, you’ll start saving money.
What Percentage of Your Monthly Payment Can You Reduce?
Let’s imagine you’re borrowing $300,000 for a 30-year fixed-rate mortgage. In this example, buying points can alter how much you pay. This will be explained using the analogy below:
How Discount Points Affect a $400,000 30-Year Fixed-Rate Mortgage
Number of Points—Cost of Points—Interest Rate—Monthly Principal and Interest Payment—Total Savings After 30 Years—Break-Even Point
• Zero points——–$0———-4.5%——–$2,027——–$0————NA
• 1 point——— $4,000——–4.25%——–$1,968——-$17,228——-68 months
• 2 points———$8,000——-4%————$1,910——–$34,047—–69 months
• 3 points———$12,000——3.75%——-$1,852———-$50,925——69 months
Disclaimer: The purpose of this table is to show how mortgage points function in general. It is not meant for financial advice or to calculate the actual costs of a particular mortgage.
Comparing mortgage costs can also be as simple as looking at the annual percentage rate of a loan. The annual percentage rate (APR) is a calculation that takes into account the loan’s interest rate, discount points, and other lender fees.
Mortgage Points: Frequently Asked Questions (FAQs)
1. Is it possible to deduct mortgage points from your taxes?
Your points may be tax-deductible because they are considered prepaid interest. However, there are some restrictions, so consult the IRS. For example, you’ll be required to itemize your deductions. If you can deduct all of your mortgage interest, you may also be able to deduct all of the points paid.
2. Is there a limit to the number of points one can buy?
While there is no formal limit on how many points you can acquire, federal and state laws limit how much you can spend on closing costs. As a result, most lenders will not allow you to buy more than 4 points.
Mortgage Points: The Bottom Line
Homebuyers can lower their interest rate and pay less each month and over the life of their loan through mortgage points. Even so, buyers who plan to relocate or refinance soon should restrategize since they may not have enough time to break even and start saving.
Bear in mind that points also raise closing expenses. As such, if you’re a home buyer paying points, be ready for the increased upfront fees. All in all, as long as a borrower has cash on hand, paying points can be a good method to save money if they plan on staying on their property for a long time.