When you want to reduce the interest rate on your mortgage loan and, in turn, lower your monthly loan payments, mortgage points are an option. While taking advantage of mortgage points can benefit buyers in the long term, they are not beneficial for everyone. So how do you know if it is worth buying mortgage points? What do the points on home loans really mean for you? To better understand, we offer you a closer look at mortgage points and how they can work to your advantage.
What are mortgage points?
Mortgage points often referred to as buying down the rate, are a way for borrowers to lower the interest rate on their mortgage, which will lower the monthly payments you make and reduce the total you pay throughout the life of the loan. A single mortgage point equals 1% of your total mortgage amount. For example, if you have a $300,000 loan, a point would be $3,000. Paying this $3,000 at closing would unlock a reduced mortgage interest rate by around 0.25%. While you are paying this amount at closing, it is not considered as an addition to your down payment. Essentially, you are purchasing this point from your lender in order to unlock the lower interest rate.
Types of mortgage points
There are two different types of mortgage points when it comes to your new home loan: Discount points and origination points. While both are often simply called points, only one can save a borrower money on the loan’s interest.
- Discount points – These points work as described above. The more points you purchase upfront, the lower your mortgage interest rate will be. How many points you can purchase depending on your lender, the type of loan, and the overall housing market at the time.
- Origination points – These points cover the costs of the lender to process your loan. These fees can vary from lender to lender, but you can negotiate these points and, in some cases, roll them into your loan and pay them over time.
Mortgage discount points vs. APR
When you purchase mortgage discount points, they lower your interest rate for the life of the loan, but they will still be a part of your annual percentage rate, or APR, and the true cost of the loan. You are just paying the portion of the interest upfront.
How to calculate mortgage points
Typically, mortgage discount points are 1% of your total loan amount, and each point can lower your interest rate by 0.25%. For example, if your initial loan amount is $200,000 with an interest rate of 4.25, each point would cost $2,000. Purchasing two points would require a $2,000 payment at closing and reduce your interest rate from 4.25 to 3.75. This would decrease your monthly interest payment by $57.65 a month, and you will save $20,753.05 in interest over the life of the loan. However, in order to yield these savings, you will need to stay in the home for at least 49 months without moving or refinancing. Moving or refinancing before this period expires means you will lose money on the points your purchased. This time period is considered the breakeven point.
Is it worth buying mortgage points?
Buying points and whether they will truly benefit you depends on various factors. Buying points may be beneficial if you:
- Plan to stay in your home for a long time
- You understand the breakeven point and do not anticipate the need to refinance or move before that point.
In many cases, buying points is not beneficial for the borrower. These times can include:
- You do not plan to stay in the home for the length of time required to reach the breakeven point
- You plan to pay extra on your monthly mortgage payments
- You do not have the extra money to purchase points
- Buying points will reduce the amount of your down payment – a higher down payment often means a lower interest rate, reduced home mortgage insurance, and lower monthly payments.
Negotiating mortgage points
In theory, all mortgage points are negotiable. The best way to negotiate lower points and closing costs is to apply for mortgages from multiple lenders. When loan offers come in, you can advise each lender that you are talking with other lenders and make them work to earn your business by negotiating lower rates and closing costs. Applying for multiple mortgages will not negatively affect your credit report, as those submitted around the same time are often considered one check. They assume you are shopping around for the best available rates, which is actually encouraged.
Deducting mortgage points on your income taxes
Mortgage discount points are essentially prepaid interest on your loan. So, just like standard mortgage interest, these payments for mortgage points can be deducted from your taxes. The expenses for mortgage points can be itemized on Schedule A.
Mortgage points and closing costs
Mortgage points, both discount and origination points, add to your down payment and additional closing costs, meaning they will increase your upfront expenses when closing on your loan. However, these points do not go toward the equity of your property.
Mortgage points can make a difference.
Mortgage discount points are optional payments offered to borrowers in order to provide savings, but they are not mandatory and, for some, are not beneficial. If you plan to stay in your new home for years, the use of points can be very beneficial in the long term. However, you need to consider things such as how much money you have available for the down payment and additional closing costs. While this may all seem overwhelming, the team at Hero Home Programs is here to help. We strive to help everyone attain homeownership and are here to answer questions and help you find the best mortgage loans, including points, possible in order to help you achieve those goals. To learn more, contact Hero Home Programs today.