The expenses can add up quickly when you find your dream home or are ready to buy your first home. Anything you can do to reduce costs can lead to long-term savings. Buying a house is one of the biggest expenses most consumers will make in their lives. Negotiating the best available interest rates and terms can help you save more. In addition, you can consider mortgage points to reduce costs. Mortgage points are discount points that can help you lower interest rates for a fee. Read on to understand mortgage points and when it’s a good idea to use them to buy a home.
Understanding Mortgage Points
Mortgage points are fees borrowers pay to lenders at closing in exchange for a reduced interest rate on their mortgage loan. Mortgage points are sometimes called discount points because you pay a fee to reduce interest. Each discount point costs 1% of the total loan amount. For example, if you purchase a home with a loan for $300,000, one discount point will cost $3,000. However, the advantage of this is that you’ll prepay interest with a small monthly payment and potential long-term savings.
Discount Points vs. Origination Points
There are two types of mortgage points. Discount points lower your interest rate. Origination points don’t lower your interest rate. Instead, they are mandatory origination fees the lender charges to review and process your loan.
They have similarities. Like discount points, one origination point equals 1% of the loan value. If a lender charges an origination fee of 1.5 origination points on a $300,000 loan, you’ll have to pay $4,500 in origination fees.
The good news is that not all lenders charge origination points on their mortgages. You may get a mortgage with reduced closing costs or no origination fees, although you’ll likely pay a higher interest rate.
You also have the option to negotiate origination points. For example, if you have 20% saved for a downpayment and a strong credit score, you have a strong negotiation position to request reduced origination points.
How Do Mortgage Points Work?
Mortgage points work to reduce the interest you’ll pay on the loan. Every 1% increase in interest rate leads to many thousands in additional mortgage payments over the mortgage term.
Each discount point reduces your interest rate by a percentage point set by the lender. This varies, but the average is a 0.25% reduction in interest per point purchased. You can usually purchase points in increments of one-eighth of a percent or 0.125%.
You have to pay points at closing. The lender calculates the points’ cost, the interest deduction and the total closing costs.
If you take out a 30-year fixed-rate mortgage for $300,000 with a 9.125% interest rate, you’ll pay significant costs over the loan’s lifetime. If each mortgage point equals a 0.25% reduction in interest, you could purchase four mortgage points for 4% of the loan value, or $12,000. Over the life of a 30-year loan, this reduction will save you over $400,000.
With an adjustable-rate mortgage (ARM), discount points function similarly. The only difference is that it is essential to understand how long the mortgage points will affect the interest rate on the loan and whether they will factor into the adjusted rate.
What Are the Benefits of Mortgage Points?
There are significant benefits of mortgage points, including:
- Cost savings: As is clear from the example above, you could save hundreds of thousands of dollars over the loan’s lifetime.
- Lower monthly payments: By paying upfront, you’ll reduce your monthly mortgage payments, reducing financial pressure.
- Tax savings: Mortgage interest is generally tax
How to Decide Whether to Pay Mortgage Points or Not?
To decide whether paying mortgage points is worth it, borrowers should consider factors such as how long they plan to stay in the home, their budget, available funds and how much they can afford to pay upfront. While mortgage points can lead to significant long-term interest savings, they won’t help much if you plan to quickly resell the home or refinance the mortgage.
For example, on a $300,000 home, you’d have to pay $3,000 for each mortgage point, reducing your interest payments by 0.25%. If you stay in the home for only five years, the additional savings probably aren’t worth the upfront expense. However, if you plan to live in the home for at least 10 to 15 years, the savings are worth the upfront costs.
For that reason, when weighing mortgage points, consider:
- How much is each mortgage point worth?
- What is the cost?
- How long do you plan to live in the home?
- When will you save more than the upfront payment?
- How else could you earn more in savings, such as investing that upfront payment?
- Do you plan to refinance within five years?
- If you’re getting an ARM, when is the first adjustment?
With the answers to these questions, you’ll have a clearer idea of whether buying mortgage points makes sense for your situation.
How Much Money Can You Save with Mortgage Point Payments?
How much you save with mortgage point payments depends on the discount amount, mortgage point costs, loan duration and whether it’s a fixed-rate or variable-rate mortgage.
For example, with a 30-year fixed-rate mortgage of $200,000 with a 9.125% interest rate, buying discount points can make sense if you plan to live in the home long-term. If each mortgage point equals a 0.25% reduction in interest, each mortgage point could equal nearly $85,000 in savings over the loan’s lifetime.
If you can afford to buy discount points on top of the down payment and closing costs, you could save a lot of money. To take advantage of this, you’ll need to stay in the home long enough to recoup the prepaid interest. If you sell the home within a few years or plan to refinance in that time, you could lose money buying discount points. In addition, if the mortgage is an adjustable rate and the adjusted rate doesn’t include the discount points, buying mortgage points may not make sense.
Should You Use Mortgage Points?
Mortgage points can help you save thousands of dollars over the loan’s lifetime, but only if you can afford to pay them upfront and the lender’s terms are favorable. Mortgage points are one more step you can take to lower mortgage payments. In addition to mortgage points, compare lenders and negotiate interest rates and total fees. The higher your credit score and the larger the down payment, the more power you’ll have to negotiate. Get started researching today with the best mortgage lenders.
Frequently Asked Questions
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Yes, mortgage points can be tax deductible, as mortgage interest payments are usually tax deductible. Speak to your accountant.
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Generally, you cannot finance mortgage points with the lender. However, you could finance mortgage points with a personal loan, although that may affect your mortgage eligibility. Generally, if you cannot afford to pay mortgage points, it doesn’t help to finance them.
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If you refinance the mortgage with a different lender, you can deduct the remaining mortgage points when you pay off the loan. If you refinance with the same lender, you’ll deduct the remaining mortgage points over the life of the loan.
