When securing a mortgage, borrowers often look for ways to reduce their monthly payments and overall loan costs. One strategy that can make a significant difference is purchasing mortgage points.
But what exactly are mortgage points, and when does buying them make financial sense?
In this guide, we’ll break down how mortgage points work, their advantages and disadvantages, and when purchasing them is a wise decision.
What Are Mortgage Points?
Mortgage points, or discount points, are fees paid upfront to a lender in exchange for a lower interest rate on a mortgage. Essentially, you are prepaying interest to secure lower monthly payments over the life of the loan.
- One mortgage point typically costs 1% of the total loan amount. For example, on a $300,000 mortgage, one point would cost $3,000.
- Each point generally reduces the interest rate by 0.25%. However, the exact reduction varies by lender and market conditions.
- Points can be fully or partially deductible on taxes, depending on your specific situation and if you meet IRS requirements.
Types of Mortgage Points
There are two primary types of mortgage points: discount points and origination points.
- Discount Points: Discount points reduce your loan’s interest rate and can help lower monthly payments. These are what people typically refer to when discussing mortgage points.
- Origination Points: Origination points are fees that the lender charges to cover the costs of processing the loan. Unlike discount points, these do not lower your interest rate and are essentially a form of lender compensation.
How Much Can You Save by Buying Mortgage Points?
The amount you save depends on several factors, including the loan amount, interest rate, and how long you plan to stay in the home. Let’s look at an example:
- A borrower takes out a 30-year fixed-rate mortgage for $300,000 at 7% interest.
- Without buying points, the monthly payment (excluding taxes and insurance) is $1,996.
- If they buy one point for $3,000, lowering the rate to 6.75%, their new monthly payment is $1,945, saving $51 per month.
- Over five years, the savings amount to $3,060, which covers the cost of the point.
- Over 30 years, the savings would be $18,360.
This means that if the borrower plans to stay in the home long enough to recoup the upfront cost, purchasing points can be a wise financial decision.
When Does Buying Mortgage Points Make Sense?
Buying mortgage points isn’t always the best choice for every borrower. Here are some situations where it makes sense:
- You Plan to Stay in the Home for a Long Time
The longer you stay in the home, the more you benefit from the lower interest rate. If you expect to keep the mortgage for at least five years or more, buying points can be a smart move.
- You Have Extra Cash Available
If you have additional savings after covering your down payment, closing costs, and emergency fund, using the extra cash to buy down your interest rate can provide long-term savings.
- You Want to Lower Your Monthly Payments
Buying points can help reduce your monthly mortgage payment, which can be beneficial if you want more budget flexibility or plan to retire on a fixed income.
- You’re in a High-Interest-Rate Environment
If market interest rates are high, buying down the rate can significantly reduce your borrowing costs over the life of the loan.
When Buying Mortgage Points Might Not Be a Good Idea
In some situations, purchasing mortgage points may not be the best financial move.
- You Plan to Sell or Refinance Soon
If you don’t plan to stay in the home long enough to break even on the cost of the points, you might not recoup your investment.
- You Need the Cash for Other Expenses
If buying points depletes your emergency savings or prevents you from making a larger down payment, it may not be the best decision.
- Your Lender Offers a No-Cost Refinance Option
Some lenders offer no-cost refinance programs, allowing borrowers to refinance without upfront fees. If you expect to refinance soon, paying for points might not be worth it.
How to Determine Your Break-Even Point?
To decide whether buying points is worth it, calculate your break-even point:
Break-Even Formula:
Break-Even Point = Cost of Points
Monthly Savings
For example:
- Cost of one point: $3,000
- Monthly savings: $51
- Break-even period: $3,000 ÷ $51 ≈ 59 months (about 5 years).
Buying points makes financial sense if you plan to stay in the home for longer than the break-even period.
Alternatives to Buying Mortgage Points
If you’re unsure whether buying mortgage points is the best option for you, consider these alternatives:
- Making a Larger Down Payment
A larger down payment reduces the total loan amount, which can lead to lower monthly payments and interest costs without the need to buy points.
- Improving Your Credit Score
A higher credit score can qualify you for better interest rates without paying for discount points. Paying off debts and ensuring on-time payments can help boost your creditworthiness.
- Shopping around for the Best Loan Terms
Different lenders offer varying rates and terms, so comparing mortgage offers can help you find a lower rate without purchasing points.
- Opting for a Shorter Loan Term
If you can afford higher monthly payments, choosing a 15-year mortgage instead of a 30-year mortgage can significantly reduce your interest rate and total loan costs.
The Final Point
Mortgage points can be a valuable tool for reducing long-term borrowing costs, but they’re not suitable for every situation. Consider your financial goals, how long you plan to stay in the home, and whether you have enough savings to cover the upfront costs.
If you need guidance on whether buying mortgage points is right for you, DSLD Mortgage can help. Visit DSLD Mortgage to explore your mortgage options and receive expert advice tailored to your financial situation.
