What Are Mortgage Points and Why Should You Buy Them?
If you’re about to buy a home, you may be wondering, should I buy points on a mortgage? Keep reading to find out if mortgage points fit your financial strategy.
May 18, 2022
It’s no secret that buying a home is a major expense. But what if there was a way to make the monthly costs of homeownership more affordable?
Enter mortgage points. You may have heard about mortgage points during the home-buying process and how purchasing them can potentially lead to a lower monthly payment.
When mortgage interest rates are high, it can be tempting to purchase points to help lower the mortgage. But, mortgage points can be pretty pricey, so it takes a decent amount of math and planning to make sure you’ll get a return on this investment.
At this point, you may be wondering, “Should I buy points on a mortgage?” Keep reading to understand:
What are mortgage points
How to buy them
How much they cost
When they make sense to purchase
What are mortgage points?
Mortgage points can help homeowners secure a lower interest rate. Each mortgage point you buy will typically lower your loan amount by 0.25%. In turn, you can end up with a lower monthly mortgage payment, translating into a lower monthly payment.
While this seems like a great deal at first glance, it may not make sense for all buyers. For example, if someone isn’t planning to stay in their home for a long time or plans to refinance soon, buying mortgage points might not make sense. It takes time to cancel out the cost of the mortgage points.
There are two types of mortgage points:
Origination points are part of the fees you pay your mortgage lender when taking out a home loan. Shopping around for different lenders lets you see who is charging the highest fees for origination points.
Discount points can help you save money by lowering the interest rate of your mortgage. Basically, discount points are a type of prepaid interest. When you pay discount points up front, you can lower your monthly payment and the cost of borrowing over the life of the loan. Usually, each discount point costs 1% of your loan amount.
Discount points can also be considered an itemizable tax deduction since they provide a way to prepay mortgage interest. This means you can take the entire deduction for those points the year you paid for them, or you can split this deduction up and claim it over the lifetime of your loan.
Having a lower monthly mortgage payment can make it easier to pay off your mortgage early and save even more on interest payments.
How much do mortgage points cost?
You can expect to spend 1% of your loan amount on a mortgage point, as noted above. Let’s say someone needs to take out a $500,000 mortgage. The cost of just one mortgage point will be $5,000.
Mortgage points aren’t cheap, so it’s important to crunch the numbers to see how many months you need to live in the home or avoid refinancing to save enough money on interest to justify purchasing those points in the first place.
How to calculate mortgage points
How can you figure out the break-even point after purchasing mortgage points?
If someone takes out a $300,000 mortgage, they’ll pay $3,000 per point. When they purchase a discount point, it lowers their interest rate from 4.5% to 4.25% on their 30-year mortgage. As a result, they’ll see their monthly mortgage payments drop by $44. They would need to pay their original mortgage loan for 68 months ($3,000 divided by $44) to break even.
Of course, you always have the option to purchase more than one mortgage point. In some cases, the homeowner can save a lot without increasing their break-even point by much.
For example, if the homebuyer decided to buy three discount points, they would spend $9,000. This would decrease their monthly payment by $131 instead of $44, and the break-even point would only increase by a month. Such a short period likely won’t impact their plans to sell their home or refinance, but saving an additional $87 a month on their mortgage payments may impact their monthly budget.
Need help crunching the numbers here? This mortgage points calculator can help you do the math.
Should I buy points on a mortgage?
Now that you know how mortgage points work, it’s time to sit down and figure out whether or not this move makes sense for you.
Finding the break-even point is a great place to start because it’ll tell you how long you need to keep the home or avoid refinancing to break even on the cost of the mortgage points. That being said, most people don’t buy mortgage points with the hope of breaking even. They do so because they want to save more on interest over the life of their loan than if they hadn’t purchased any discount points.
Usually, buying discount points makes the most sense when someone:
Plans on living in their home past the break-even point
Won’t benefit from refinancing their mortgage before the break-even point
Can afford to buy mortgage points comfortably
Take a close look at your budget before buying mortgage points. Homeownership comes with many expenses, and setting that money aside for repairs, renovations, property taxes, insurance, maintenance, or furniture might be helpful, especially if you aren’t sold on this home being your forever home.
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