Purchasing mortgage points from your lender can lower your interest rate and make your monthly mortgage payments more affordable. If you’re considering a home purchase or refinance, mortgage points could save you tens of thousands of dollars over the life of the loan.
In this article, we’ll explain what mortgage points are and present the pros and cons of buying mortgage points
What Does Buying Points Mean in a Mortgage?
Mortgage points, also called discount points, are an upfront fee that a borrower pays their mortgage lender to cut down the interest rate on their loan.
Borrowers can lock in a lower interest rate on a purchase or refinance loan and pay less on their mortgage over time. This may make more sense for borrowers who plan to stay in their homes for a long time.
How Much Is One Point on a Mortgage?
One point typically costs 1% of your loan amount and lowers your mortgage interest rate by about 0.25%. For example, on a $100,000 loan, one point would cost $1,000. Mortgage points also don’t have to be round numbers — they can also be fractions of a point.
How much each point lowers your mortgage interest rate varies by lender. It also depends on the type of loan product as well as the current interest rate environment. This is why it pays to shop around with a few lenders and compare quotes.
You can also purchase discount points for an adjustable-rate mortgage (ARM) loan, which works the same as it would for a fixed-rate mortgage. However, most ARMs adjust after five or seven years.
Mortgage points are paid at closing and according to Consumer Finance, they are listed on your Loan Estimate and your Closing Disclosure on page 2, Section A. By law, the points listed on these documents must be connected to a discounted interest rate.
Pros and Cons of Buying Points on a Mortgage
Pros of Buying Mortgage Points
The biggest benefit of buying mortgage points is lowering the interest rate on your loan, no matter your credit score. This saves you money not only on your monthly mortgage payments but also on total interest payments.
Buying down your rate also reduces the total cost of the home. Paying an extra $3,000 upfront could save you thousands more over the life of the mortgage loan.
Mortgage points are also tax-deductible. The IRS considers mortgage points to be prepaid interest, which may be deductible as home mortgage interest if you itemize deductions. If you deduct all interest on your mortgage, you may be able to deduct all of the points.
Calculate how much you can save on your mortgage payments with Total Mortgage.
Cons of Buying Mortgage Points
Buying mortgage points isn’t recommended for everyone. If you don’t have the extra cash reserves, paying for mortgage points on top of your closing costs and down payment could drain your savings.
If you’re purchasing a house and putting less than 20% down on a conventional loan, the added expense of private mortgage insurance (PMI) may not make much financial sense. It may be better to put those funds towards your down payment.
It could also take a while to break even, which is the time it takes for the monthly savings to pay for the points.
For instance, let’s say you purchased 3 mortgage points for $9,000 on a $300,000 home loan financed over 30 years. This lowered your interest rate from 3.5% to 2.75% and saves you $122 per month. However, your break-even point is a little over six years and if you move or refinance before then, you may not recoup that upfront cost.
Also, interest rates fluctuate. If rates go down after purchasing mortgage points, then the value of the points would essentially be worthless.
Mortgage Points vs. Lender Credits
You may also come across lender credits, which are similar to mortgage credits but in reverse. Your lender may offer a higher interest rate in exchange for extra funds to offset your closing costs. Lender credits mean you pay less upfront but you pay more over time in interest.
Lender credits are also calculated the same way as mortgage points, but they may appear as negative points on the Lender Credits line item on page 2, Section J of your Loan Estimate or Closing Disclosure.
Should You Buy Mortgage Points?
Although mortgage points can potentially save you money over the long run, they aren’t for everyone and it could take between five and 10 years to recoup the cost of the points.
Here are some instances where buying mortgage points may be worth your while:
- You have the extra money to put down without draining your savings
- You plan to live in your home for a long time
- Your credit score doesn’t qualify you for the lowest possible rate
- You need to lower your interest rate to make your monthly mortgage payments more affordable
Here are some reasons why you shouldn’t buy mortgage points:
- You’re planning on selling your property in a few years
- You’re going to pay extra on your mortgage payments
- You don’t have the money to buy mortgage points
- It would reduce your down payment amount
If you’re deciding whether to direct extra funds toward your down payment or buy mortgage points, a larger down payment usually has more benefits compared to mortgage points.
A bigger down payment can get you a better interest rate, cheaper PMI (or none), or lower mortgage payments.
Build Your Perfect Mortgage With Total Mortgage
Mortgage points can potentially save you money on your mortgage loan, but the monthly savings will depend on the interest rate, the amount you borrow, and the term of the loan. However, mortgage points may not be the best financial move for your situation.
The right mortgage can save you thousands. Get a free rate quote from Total Mortgage for a home purchase, refinance, or home equity loan.
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