Buying a home involves a lot of research, including choosing the right type of mortgage and determining the interest rate you will pay. A way to lower your interest rate is to buy mortgage points. But what exactly are mortgage points, and how do they work?

we explore all the benefits and drawbacks of mortgage points and how to calculate the breakeven point.

 

What are mortgage points?

The purpose of mortgage points is to reduce the interest the borrower will pay over the life of the loan. Borrowers pay points when applying for a mortgage to get a lower interest rate. This practice is sometimes called "buying down the interest rate."

Buying one point costs 1 percent of the mortgage amount. That means on a $300,000 mortgage, one point would cost $3,000.

The point system is a type of prepaid interest. You pay a predetermined amount of money to reduce the interest rate of your loan by a certain percentage, usually 0.25 percent. You can pay as little as one point or as much as three points.

It is possible to lower your monthly payment by reducing the loan's interest rate. Still, you will need to make an upfront payment. The longer you plan to live in a home, the more benefits you will receive from paying for points.

 

Origination Points vs. Discount Points

You should distinguish discount points from origination points - another mortgage point that lowers your interest rate.

Instead of discount loans, origination points are not discretionary and will not affect your interest rate. An origination fee is a charge by a lender for processing your loan application. One origination point usually equals 1 percent of the total mortgage amount. Typically, you pay your origination points when you finalize your home purchase as part of your closing costs. For example, 1.5 origination points on a $250,000 mortgage would cost you $3,750.

Mortgage lenders do not always charge origination points. Some lenders allow borrowers to obtain a mortgage with no- or reduced-closing costs; however, they compensate by raising interest rates.

There is also a possibility of negotiating origination points. Well-qualified buyers can sometimes get lenders to lower origination points by putting down a 20 percent down payment and maintaining a high credit score.

 

What is the process of mortgage points?

Buying a discount point reduces your interest rate by a certain percentage. Although most mortgage lenders limit the number of points purchased, you can expect an interest rate reduction of 0.25% for every point you buy. In addition to purchasing points in eighths of a percent, you can also purchase 0.125% points.

Your lender will add points to your other closing costs when you purchase points.

Let's take a look at an example. Your lender is willing to offer you an interest rate of 4.75% if you purchase 1.75 mortgage points. You are taking out a 30-year fixed-rate mortgage for $200,000 at an interest rate of 5.125%. For a $200,000 loan, each point costs $2,000. For your loan, 1.75 points cost $3,500. A 5.125% interest rate will remain if you don't buy mortgage points.

It costs $391,809 for a 30-year mortgage if you don't pay down the loan early. If you buy 1.75 mortgage points for the loan, it costs $375,586 over 30 years. With mortgage points, you would save $16,223 over 30 years.

A discount point works similarly to a fixed-rate loan for an adjustable-rate mortgage (ARM). You need to know how long it will take for your points to be worth the investment on an ARM when the interest adjusts after 5 or 7 years.

 

Advantages and disadvantages of mortgage points

Consider both the pros and cons of mortgage points before purchasing them. Here are a few of the pros and cons of mortgage points:

Advantages of mortgage points

• Lower interest rates: Point purchases lower the interest rate on your mortgage, resulting in lower monthly payments and a lower overall interest rate.
• Tax deductions: Tax deductions for mortgage points are allowed by the IRS, allowing homeowners to save significant amounts each year.

Disadvantages of mortgage points

• Upfront cost: The upfront cost of mortgage points is paid at closing. You will have to pay a higher initial mortgage payment as a result.
• Might only sometimes save you money: Low-interest rates only save you money when the savings overshadow the points' cost - known as the breakeven point. Your points will not provide a financial benefit if your home is sold or refinanced before this point.
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Are mortgage points worth buying?

If you plan to buy mortgage points, here are some things to consider. Lower interest rates are always great, but points are only suitable for some.

Buy mortgage points at the right time.

The following situations may make sense if you buy mortgage points:

Long-term homeowners should consider investing in points and lowering their mortgage rates as they stay in their homes longer. Mortgage points can reduce the overall cost of the loan if you keep the same mortgage for many years.

The breakeven point for your mortgage is known to you. Do your math to figure out when you'll save more than your points on your monthly mortgage payments to offset the upfront cost of the points. You should consider buying points if you don't plan to move or refinance your loan before you reach the breakeven point.

Buying points on a mortgage can be a risky move.

There are several reasons why you should not buy mortgage points:

Your home is going to stay on the market for a while. You will benefit from discount points if you plan to sell in a few years. The interest savings will take a few years to offset the points' cost. Buying mortgage points might not be worth it if you know you'll move soon.

If you repay your loan quickly, you might save a little money by investing in mortgage points. Mortgage points are only beneficial if you keep your home loan for an extended period.

You can save on interest by paying extra toward your loan's principal balance even if you don't have money to buy points. You should keep your savings account to save on interest.

Any extra money you have would be better spent on your down payment than on points. Generally, making a larger down payment when buying a home can result in benefits such as a lower interest rate, less mortgage insurance, or smaller monthly payments. There are only some of these benefits to mortgage discount points.

When interest rates are high, buying points is a good idea when you plan to refinance soon. However, if you plan to refinance, you will pay origination and discount points for the new loan, which means you must pay them twice.

 

FAQs about Mortgage Point

It would help to examine your circumstances before deciding whether to invest in mortgage points. Find out more about making this upfront investment by reviewing the answers to these frequently asked questions.

 

How many discount points should I buy if mortgage interest rates continue to rise?

Mortgage rates have steadily climbed in recent years, making discount points more attractive. Calculating your break-even point is a great way to determine whether discount points are right for you. The down payment or shorter repayment period may be better suited if you aren't planning on refinancing soon or have yet to reach breakeven.

 

Does the number of points I pay on my mortgage affect my APR?

You can purchase mortgage points to lower your interest rate and lower your annual percentage rate (APR).

 

Can I write off the points I bought for my mortgage?

A tax advisor can help you determine whether you can claim mortgage points as a deduction on Schedule A (Form 1040). Mortgage points can be treated as prepaid interest by the IRS. If you itemize deductions, you can claim them.

 

Bottom Line

It will only be financially advantageous for some to buy mortgage points. You'll need to crunch the numbers to see if discount points can save you money.

Before you get to the closing table, take a moment to evaluate your budget, down payment, loan terms, and plans. You can determine whether you can offset the cost of the points by staying in the home for long enough to save enough money on interest.

Apply online with Mortgage Dove today if you're ready to buy a new home or refinance your home loan.