When you’re in the market for a mortgage, you might come across the term “mortgage points” and wonder if they’re worth your investment. Mortgage points, also known as discount points, can be a bit confusing, but understanding them can help you make a more informed decision about your home loan and locking in your mortgage rate. This article will break down what mortgage points are, how they work, and whether they’re worth considering for your mortgage.
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What are mortgage points and should you buy them?
Mortgage points are upfront fees you can pay out of pocket to reduce your overall mortgage interest rate. On average, one mortgage point costs around 1% of your total loan amount and lowers your interest rate by a certain percentage, usually by 0.25%, though this can vary by lender. For example, if you’re taking out a $438,837 loan, one point would cost $4,388.37 and could reduce your interest rate by a quarter of a percent.
The idea behind paying for points is to save money over the long term by securing a lower interest rate. This can be particularly appealing if you plan to stay in your home for an extended period. By paying for points upfront, you’re essentially lowering your monthly payments and over the life of the loan you’ll see significant savings.
Is it worth buying points for a lower interest rate?
Whether buying mortgage points is a good deal depends on several factors, including how long you plan to stay in your home and how much you’re willing to pay upfront. To determine if paying for points is worth it, you need to calculate your breakeven point — the point at which the upfront cost of the points is offset by the lower monthly payments.
To do this, divide the cost of the points by the amount you save each month with the reduced interest rate. For example, if you pay $4,388.37 for one point and your monthly payment decreases by $100.00, your breakeven point would be just about 44 months (Equation below for quick reference). If you plan to stay in your home for longer than this period, buying points might be a wise investment.
Breakeven Point Equation: ($4,388.37 ÷ $100 ≈ 43.88 months)
However, if you expect to move or refinance within a few years, paying for points might not be cost-effective. In this scenario, the upfront cost of the points might not be recouped before you sell or refinance your home.
How much does one point reduce a mortgage rate by?
Typically, buying one mortgage point lowers interest rate by about 0.25%. This can vary depending on the lender and market conditions, but 0.25% is a general rule of thumb. For instance, if your original mortgage rate is 6.43%, buying one point might reduce it to 6.18%. While this might seem like a small difference, over the life of a 30-year loan, it can lead to substantial savings.
To put this in perspective, on a $438,837 mortgage, a 0.25% reduction in interest rate could potentially save you upwards of $25,000 in interest over the life of the loan. This makes buying points a potentially attractive option if you’re in it for the long haul. Particularly when you consider the fact that mortgage rates continue to drop in the current climate.
What is the disadvantage of points on a mortgage rate?
The primary disadvantage of paying for mortgage points is the upfront cost. For some borrowers, coming up with the additional cash can be a significant hurdle. If you’re already stretching your budget to afford the down payment and closing costs, paying thousands of dollars to buy points might not be feasible.
Additionally, if you sell or refinance your home before reaching the breakeven point, the cost of the points won’t be recovered. This means you could end up losing money if you don’t stay in your home long enough to reap the benefits of the lower interest rate. This is why you need to understand where your breakeven point is.
There’s also the opportunity cost to consider. The money spent on points could be used elsewhere, such as in investments that might offer a higher return. If you’re someone who prefers to keep your cash available for other uses, paying for points might not align with your financial strategy.
Does buying points affect your down payment?
Buying mortgage points is an investment in reducing your loan’s interest rate and does not impact your down payment. The down payment is the portion of the home’s purchase price you pay upfront, which directly reduces the loan amount needed.
Mortgage points are an additional cost incurred at closing, separate from the down payment. For instance, if you’re purchasing a $438,837 home and make a 20% down payment of $87,767, any points you choose to buy are added on top of this amount. Ensure you have adequate funds to cover both your down payment and the cost of points to avoid financial strain.
Is it worth paying for a lower mortgage rate?
Deciding whether it’s worth paying for a lower mortgage rate hinges on your personal financial situation and your long-term plans. Here are some considerations to help you make an informed decision:
- How long you plan to live in your home: If you plan to stay in your home for many years, 3 to 5 years or more, then paying for points can be a smart move. The longer you stay, the more you’ll benefit from the lower interest rate, making it easier to recover the initial cost of the points.
- Budget: Assess your current financial situation. If you have the extra cash available and can afford the upfront cost without straining your budget, buying points might be worth it. Conversely, if paying for points would deplete your savings or affect your ability to cover other expenses, it might not be the best option.
- Interest rate environment: Consider the current interest rate environment. If rates are low and expected to rise, locking in a lower rate by paying for points might be advantageous. However, if rates are expected to drop or remain stable, you might not need to pay for points.
Wrapping up: paying for points for a lower mortgage rate
Mortgage points can be a valuable tool for reducing your interest rate and saving money over the long term. They can be particularly beneficial if you’re planning to stay in your home for an extended period and have the financial flexibility to pay for them upfront. However, if you’re likely to move or refinance soon, or if the upfront cost of points is a strain, you might want to reconsider. Carefully evaluating your situation and doing the math will help you determine if paying for mortgage points is the right choice for you.
