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Understanding Mortgage Points
When you’re buying a house, there seems to be an endless number of decisions you need to make. One thing you may be hearing about for the first time are mortgage points. Touted as a way to lower your mortgage rate, should you buy them, what are mortgage points and can they save you money? It all depends. For some people, mortgage points can be a worthwhile investment, while for others, they are better left out of the contract.
What are mortgage points?
Mortgage points are a way for you to pay an upfront fee when closing on a house to lower your mortgage rate for the life of the loan. Generally, a mortgage point costs 1.00% of the total mortgage and lowers your fixed-interest rate for the life of the loan by 0.25%. While lenders are not required to offer the opportunity to purchase mortgage points, most allow you to purchase up to three or four points.
Here’s what this would look like on a $200,000 fixed-rate loan with a 4.00% interest rate if you were interested in purchasing two points. To calculate your mortgage points cost, figure out what 1.00% of your loan is. In this case, it would be $2,000. Since you are buying two points, the total cost upfront would be $4,000. In return for this, your rate would be lowered from 4.00% to 3.50%. By paying your mortgage lender $4,000 upfront, you’re able to lower your interest rate for the life of the loan.
How do mortgage points cut your interest rate?
By their very nature, mortgage points are an arrangement to lower your interest rate for the life of the loan. For a percentage cost of your total loan, you can bring down your rate by 0.25% per purchased mortgage point. Once you purchase your points from the lender, the savings are automatically applied. You are required to pay the full cost of the mortgage points upfront, though.
The interest rate savings are realized slowly over the life of your loan with each payment. For example, the monthly payment on the previous example loan without the points at 4.00% would be $955 per month. When you purchase the two points and bring the rate down to 3.50%, your monthly payment goes down to $898.
What’s the point of mortgage points?
The point of purchasing mortgage points is to lower the interest rate on your mortgage loan. While this sounds appealing, the benefit and savings are not always realized in all situations.
- Savings for people who stay in their home longer: You don’t save the full cost of the mortgage points right away. The savings are spread out over each payment for the life of the loan. There is a break-even point where you will have saved equal to the cost of the mortgage points. If you stay in your home longer than that point, you start to realize the savings. If you sell before that, though, you will be losing out on the deal.
- Good for people with extra capital: Buying a new home is expensive, and the thought of tacking on a few thousand dollars extra to the equation just doesn’t work for many people. If you do have the extra cash and are planning on staying in the home past the break-even point and not refinancing, though, it may be a good fit.
Pros and cons of mortgage points
The debate on the merits of mortgage points is best settled by looking at the pros and cons. The reality is that for some people buying mortgage points will bring big savings, and for others, it would be a wasted investment.
- Lowers your interest rate: The biggest pro of mortgage points is that it lowers your interest rate for the entire duration of the loan.
- Lowers your payments: When your interest rate goes down, the size of your payments also goes down.
- Can generate long-term savings: If you stay in your home past the break-even point and don’t refinance, you can generate a lot of interest savings on your loan.
- Requires upfront costs: Mortgage points must be paid in full upfront. This can be pricey, especially when you’re already paying all of the other costs of buying a home.
- Negated with refinancing: If you refinance before the break-even point, you will lose out on a lot of the money that you paid for the points. There are no refunds for the costs.
- Not good if you aren’t staying: If you leave before the break-even point, you’ll cease to get any more of the savings that you paid for.
Are mortgage points worth it?
Ultimately, determining if mortgage points are worth it will come down to two things — how long you’re going to stay in your home and what your cash situation at closing looks like. You can use a break-even mortgage points calculator to determine how long you would need to stay in your home to start realizing savings from mortgage points. If you’re planning on staying long enough, the points could be worth it.
The second thing to look at is the cost of the points. If you don’t have the additional capital upfront to pay for the points, it’s not going to be a worthwhile investment. Additionally, mortgage points have been criticized by some because you could spend that money on an independent investment and earn more than you would save with the points. The validity of this would depend on what investments are available to you and what your risk tolerance is.