Want to pay less on your mortgage? Here’s the key: Buying mortgage points can lower your interest rate and save you thousands over the life of your loan. Here’s a quick breakdown:
- What are mortgage points? Upfront fees you pay to reduce your loan’s interest rate. Typically, 1 point costs 1% of your loan amount and lowers your rate by about 0.25%.
- Example savings: On a $200,000 loan, paying $2,000 for 1 point can reduce your rate from 4.5% to 4.25%, saving $29.49/month or $8,616.40 over 30 years.
- When it’s worth it: If you plan to stay in your home long enough to recoup the upfront cost (break-even point), buying points can provide long-term savings.
- Key considerations: Length of stay, upfront cash availability, and loan size impact whether points make sense.
Quick Tip: Calculate your break-even point by dividing the cost of points by the monthly savings. For example, if points cost $3,000 and save $100/month, you’ll break even in 30 months.
This guide explains how mortgage points work, when to use them, and how they can save you money. Read on for more insights and examples!
How Mortgage Points Lower Your Rate
What Are Mortgage Points?
Mortgage points are an upfront payment made to your lender to reduce the interest rate on your home loan. Essentially, you’re prepaying interest to save money over the life of the loan. For example, on a $300,000 loan, one mortgage point costs $3,000. Lenders often let you buy fractional points, usually up to three points, so you can adjust your upfront costs based on your budget and goals [1].
Now, let’s break down how these costs translate into lower interest rates.
How Points Affect Your Rate
The impact of mortgage points on your interest rate depends on the lender. Here’s a snapshot of how buying points can reduce your rate and monthly payments:
| Points Purchased | Cost on $300,000 Loan | Rate Reduction | New Rate (from 4.5%) | Monthly Payment Change |
|---|---|---|---|---|
| 1 point | $3,000 | -0.25% | 4.25% | $1,520.06 to $1,475.82 |
| 2 points | $6,000 | -0.50% | 4.0% | $1,520.06 to $1,432.25 |
Even a small drop in your interest rate can lead to noticeable monthly savings. Over time, these reductions can add up significantly [1].
Long-Term Savings: Is It Worth It?
Calculating long-term savings helps determine whether buying points makes sense for you.
"The pros are that the borrower receives a lower payment and pays less interest over time. The cons are that they have to put more money into the transaction upfront out-of-pocket, and if they don’t remain in the home for a certain time, the cost is more than the benefit received." – Chuck Meier, Senior Vice President at Sunrise Banks [2]
For instance, on a $350,000 loan with a 7% interest rate, purchasing two points for $7,000 reduces the rate to 6.5% [4]. Here’s how it breaks down:
- Monthly savings: Around $117
- Break-even period: About 60 months (5 years)
- Total 30-year savings: Approximately $41,875 (after subtracting the cost of points) [4]
Staying in the home beyond the break-even point is key to maximizing these savings.
"To do so, you need to calculate the cost versus savings over time. This is done by comparing rates with no points to a loan with points and reviewing the overall annual savings in the monthly payment." – Katherine Alves, Executive Vice President of Homeowners First Mortgage [2]
Should You Buy Mortgage Points?
Calculate Your Break-even Point
Let’s break it down using a $350,000 mortgage and these point options:
| Points | Interest Rate | Upfront Cost | Monthly Payment | Monthly Savings | Break-even Time |
|---|---|---|---|---|---|
| 0 | 6.00% | $0 | $2,098 | — | — |
| 1 | 5.75% | $3,500 | $2,043 | $55 | 64 months |
| 2 | 5.50% | $7,000 | $1,987 | $111 | 63 months |
To calculate your break-even time, divide the upfront cost of the points by the monthly savings. These numbers help you decide if paying for points makes financial sense [5].
Key Decision Points
Deciding whether to buy points depends on how they align with your financial goals. Consider these factors:
- How long you’ll stay in the home: Staying beyond the break-even point makes points worthwhile.
- Available cash: Ensure you have enough funds left after covering your down payment and reserves.
- Loan size: Larger loans result in higher monthly savings from points.
"The use of discount points can be a great strategy to implement when it comes to mortgage financing. However, there needs to be some analysis done to confirm whether the savings seen with a reduced interest rate will outweigh the cost of the discount points and how that factors into your long-term plans for the property in question." – Robert Killinger, senior loan officer at Mortgage Network [2]
Best Cases for Buying Points
Here are scenarios where buying points works best:
- Long-term Homeowners: If you plan to stay in the home for 10+ years, the savings from points will add up over time.
"The longer the horizon, the more advantageous it is to prepay interest through points." – Katsiaryna Bardos, chair and associate professor of the Finance Department at Fairfield University [2]
- Investment Property Owners: Landlords can benefit from lower monthly payments, boosting rental income [2].
- High-Income Borrowers: If you have extra cash, buying points can reduce long-term interest costs while keeping other investment options open.
However, points might not be a good fit if:
- You plan to sell within 5 years.
- You don’t have enough cash for the down payment and reserves.
- You expect to refinance before reaching the break-even point [2].
Making Points Work for You
Getting Seller Help with Points
In some cases, sellers might cover the cost of your mortgage points, which can be a smart move when the market favors buyers. By paying for points, sellers effectively lower the interest rate on your loan, making their property more appealing without reducing the sale price. For instance, one seller spent $13,600 to bring the interest rate down from 4.25% to 3.75%, improving the overall financial outcome of the deal. This tactic, along with others, can be an effective way to secure a lower interest rate [6].
"We did a ton of buy-downs on resales between 2006 and 2009… in the right circumstances, they can be a pretty good opportunity for sellers and buyers to come together on a deal, even with today’s lower mortgage rates." – David H. Stevens, president and chief executive of the Mortgage Bankers Association [6]
Combining Points with Other Financing Strategies
Seller contributions are just one piece of the puzzle. You can pair mortgage points with other strategies, like making a larger down payment, to reduce your interest rate and monthly payments even further. Talk to your lender about how different down payment amounts could affect your rate. This will help you strike the right balance between upfront cash and long-term savings. Using these approaches together can make discount points even more effective [1].
Points for Large Loans
When it comes to big loans, buying points becomes even more appealing. Larger loans amplify the impact of points, as the savings on monthly payments increase with the loan size. For jumbo loans, where each point costs 1% of the loan amount, the potential monthly savings can be substantial. This makes the cost of points more worthwhile, as the savings and break-even benefits are more pronounced [1][5].
"Keep getting the benefits of lower monthly mortgage payments for as long as they have the mortgage." – Oray Nicolai, senior mortgage banker with Access National Mortgage [6]
sbb-itb-8115fc4
Mortgage Points Explained: How & When to Buy Down Your …
Steps to Buy Points
Here’s how you can navigate the process of buying mortgage points effectively.
When to Discuss Points
Bring up the topic of mortgage points during your initial conversation with your lender. Once you submit your loan application, the lender will provide a loan estimate. This document will outline the cost of available points and how they impact your interest rate [3]. For instance, on a $200,000 mortgage, one point typically costs about $2,000. Once you have these details, you can move forward with gathering the necessary paperwork.
Required Documents
You’ll need the following documents to proceed:
- Proof of Funds: Evidence that you have enough money to cover the cost of points and closing fees.
- Loan Estimate: A breakdown of point costs and the interest rate reduction they offer.
- Closing Disclosure: A final document confirming the agreed terms.
Mortgage points are paid at closing, along with other associated fees [4].
"A mortgage point – sometimes called a discount point (or a prepaid interest point) – is a one-time fee you pay to lower the interest rate on your home purchase or refinance." – Rocket Mortgage [4]
Points on Loan Documents
After gathering the required documents, carefully review your loan paperwork to confirm the accuracy of the terms related to points.
Pay special attention to these sections:
- Loan Estimate: This outlines the number of points you’re purchasing, their cost, and the resulting reduction in your interest rate.
- Closing Disclosure: This section confirms the final cost of the points under "Loan Costs" and specifies the final interest rate.
- Monthly Payment Breakdown: This shows your adjusted monthly payment, the interest savings, and the total cost of the loan with points applied.
Double-check all details related to points, as some lenders might include them automatically without clear communication.
Risks and Limitations
Mortgage points can help lower your interest rate, but they come with certain trade-offs that need to be carefully evaluated.
Initial Cost Impact
Buying mortgage points means paying a noticeable upfront cost, as each point equals 1% of your loan amount. For instance, purchasing one point on a $300,000 mortgage would cost $3,000, while a $200,000 loan would require $2,000 for the same.
It’s important to ensure you have enough cash left over for other expenses like emergency repairs, moving costs, or necessary home upgrades. These upfront costs can also impact your financial health, particularly your debt-to-income (DTI) ratio.
DTI Ratio Effects
Spending on mortgage points can influence your DTI ratio, potentially requiring additional borrowing to cover expenses.
| Area of Impact | Effect on Loan Approval |
|---|---|
| Cash Reserves | Reduced funds may lead to borrowing for emergencies |
| Monthly Payments | Lower interest rates reduce payments, but closing costs rise |
| Overall Debt | Using credit for upfront costs increases total debt |
Understanding how this affects your financial standing is key, and tax considerations add another layer of complexity.
Tax Considerations
How mortgage points affect your taxes depends on their purpose and the type of property:
-
Points on a Primary Residence
If the points are for your main home, they may be fully deductible in the year you pay them – provided you meet IRS rules, such as using the cash method of accounting and basing the points on a percentage of the loan principal. -
Investment Property Points
For investment properties or second homes, points are usually deducted gradually over the loan’s term rather than all at once. -
Refinance Points
When refinancing, points are typically deducted over the new loan’s term. If you refinance with a different lender, you might be able to deduct any remaining points from the original loan in the same year as the refinance.
Because tax laws can vary and change, it’s a good idea to consult a tax expert to understand how these rules apply to your situation.
Next Steps
To figure out your break-even timeline, divide the cost of the points by your monthly savings. For instance, if one point costs $3,000 and saves you $100 a month, you’ll break even in 30 months. This simple calculation helps you decide if buying points matches your homeownership plans [7]. Once you have these numbers, consider your overall financial position using the key points below.
Key Considerations
When deciding on mortgage points, keep these factors in mind:
| Factor | What to Consider |
|---|---|
| Cash Position | Do you have enough money to pay for points while keeping an emergency reserve? |
| Home Timeline | How long do you plan to stay in the property? |
| Monthly Budget | Will lower monthly payments outweigh the upfront cost of the points? |
| Tax Situation | Are there potential tax deduction benefits available for you? |
Speaking with a financial advisor can help you understand how points might affect your finances.
Get Professional Guidance
Once you’ve crunched the numbers and thought through your situation, getting professional advice can help you make the best decision. A knowledgeable loan officer can:
- Review current market rates and point costs
- Assess your financial situation
- Calculate potential savings
- Advise whether points align with your overall strategy
Fill out the Quick Start Form to connect with a loan officer who can help you find the right loan program for your needs.
Taking these steps will help you make informed decisions to fine-tune your mortgage strategy.
Related posts
