If you’re preparing to buy a house, you know there’s a plethora of things to consider. While you might want to focus on the fun stuff like paint colors and flower planting, first you need to consider the financial aspects of getting into a house.
First, you’ll worry about saving for a down payment and cleaning up debt so you can find the best mortgage. Then you’ll need a good mortgage broker and decent mortgage interest rates. There’s a lot to consider with mortgages.
As you learn more about home mortgages, you might be wondering about mortgage points and whether they’re a good idea for you.
Read on to learn more about mortgage points, what they are and when they’re a smart idea for a mortgage.
What Are Mortgage Points?
When you buy a house, you know what of the most important factors to consider is the mortgage. You want to pay attention to the interest rate and how that’ll impact your monthly payments and terms of the mortgage overall.
A borrower can do something called buying a mortgage point. This means they pay money upfront to the lender in order to lower the interest rate of the mortgage. Since a lower interest rate means paying less interest over the course of the loan and a lower payment each month, buying points can be desirable.
Types of Mortgage Points
There are a few different types of mortgage points to consider.
You could buy mortgage points to get a better mortgage rate on your loan. These are commonly referred to as discount points. While you pay for them upfront at closing, they offer you a discounted rate from the current mortgage rates on the market.
Discount points in the mortgage industry are sometimes referred to as “buying down the rate” since your upfront money helps to lower the interest rate on the loan.
The second type of mortgage point is called the mortgage origination point. This is when the borrower pays the lender origination points to originate, review and process the loan.
For the purposes of the article, we’ll focus on mortgage points used as discount points to lower the overall interest rate of your mortgage.
How Do Mortgage Points Reduce the Current Mortgage Interest Rate?
Before answering how mortgage points reduce rates, it should be noted that all lenders are different. Rates are in a constant state of flux and change over the course of even a day. This is partly why you hear the term lockin in your rate.
To lock in your rate, you’re securing a current rate for a period of time that’s desirable to you. Because rates are in flux all the time and can vary from lender to lender, you want to shop for the best terms of a mortgage.
Having said that, let’s discuss generally how mortgage points can reduce your mortgage interest rate overall.
When you buy points, (remember commonly called “buying down the rate”), you pay 1% of your mortgage amount to the lender at closing. In return for the additional cash up front, your lender lowers your interest rate.
Commonly, purchasing a point will lower your interest rate by .25%. Again, it varies by lender and the terms of the loan.
Mortgage Points Scenario
While it’s a whole lot of numbers, let’s take a look at a common scenario to better understand mortgage (discount) points.
Let’s say you’re borrowing $200,000 at a 4% interest rate. You opt to buy 2 mortgage points which is likely going to cost you around $4,000 extra at closing. In return for the upfront money to your lender, they lower your interest to 3.5%.
At 4%, your monthly payment is approximately $954 for the mortgage itself. At the 3.5% rate, the monthly payment drops to $898, saving you $56 per month.
Over the course of the loan is where this lower rate becomes significant. If you have a 30-year fixed-rate mortgage using these numbers, you’ll save close to $21,000 in interest from your initial $4,000 investment in buying the points.
Break-Even Point
When you consider buying points, it’s part speculation and calculation. You can use a mortgage calculator to see your actual rates savings from buying the points.
But in order to decide if buying the points is worth the investment, you need to consider how long you plan to stay in the house.
If you think you’re buying a forever home, where you anticipate staying over the course of the mortgage it’s likely worth it. If you are buying what’s commonly called a starter home and only plan to stay for a few years, then buying the points upfront might not be worth it.
To decide, take the initial investment cost of buying the points, and divide it by the savings each month. This helps you see how long you need to stay in the house to make it worth it.
In the above scenario, a $4,000 investment divided by a $56 monthly savings means you need to stay in the house for close to 6 years before you break even and start to make money on the investment of buying the points.
Mortgage Points and Adjustable-Rate Mortgages
If you’re considering an adjustable-rate mortgage, it becomes even more important to know when your break-even point will be. First, you need to know when your adjustable-rate mortgage makes a rate adjustment.
If your ARM adjusts after five years, for example, you want to factor in a potential rate change and how that will impact your break-even calculation.
Mortgage Points and Taxes
Mortgage points might be tax-deductible if you do an itemized tax form. The IRS changes the criteria for mortgage write-offs yearly. If you’re considering buying points, it might be worth checking with your tax accountant to see if you qualify for the deduction as it’s another way to garner some savings.
Understanding the Impact of Mortgage Points on Your Mortgage
Buying mortgage points can be a smart idea if you have the money upfront to invest as they can provide big savings over the period of a mortgage. You’ll want to anticipate that you’ll stay living in the house long enough to recoup your initial investment in the points.
If you’re looking for a mortgage or have more questions about mortgage points for your loan, contact us today to set up an appointment to learn more about our mortgage services.
