What are mortgage points? Why are some homebuyers eager to purchase them, while others skip them? If you’re on the fence about mortgage points, how do you decide which way to jump? Learning what mortgage points are and exploring their pros and cons will help you make an educated decision.
What Are Mortgage Points?
As Investopedia explains, there are technically two types of mortgage points: origination and discount.
Origination points are a form of compensation for loan officers. Some lenders refer to these charges as origination fees to avoid confusion. Discount points, the variety of mortgage points that most people are actually talking about when they use the term, are basically prepaid interest. Purchasing discount points is a way to lower your interest rate. This can reduce both your monthly mortgage payment and the total cost of your home loan.
How Do Discount Points Work?
What do mortgage points cost? As Credit Karma explains, that depends on your loan. Normally, a point’s cost is equal to 1% of the amount that you’re borrowing. Lenders typically allow borrowers to buy up to three points; some offer the opportunity to buy fractions of a point. Each point reduces your interest rate by certain amount.
Imagine that your lender offers to reduce your rate by 0.25% for each point that you purchase. If you’re borrowing $100,000, then you’ll need to purchase 2 points at the cost of $2,000 to drop your rate by 0.50%. You’ll need to pay for any points that you purchase at closing, so buying points increases the upfront cost of your loan in return for potential savings down the road.
The Benefits of Points
What are mortgage points good for? Policygenius reports that people tend to purchase mortgage points for the following three reasons:
- Lower Monthly Payments: A chunk of every month’s payment goes to paying off interest, so snagging a lower interest rate shrinks your monthly mortgage bill and frees up money for other things.
- Long-Term Savings: Mortgage points do come at a cost, but if you continue with the same loan long enough, you’ll eventually break even. After that time, the reduction in monthly payments amounts to pure savings that could total thousands of dollars.
- Tax Deductions: Because they’re recognized as a form of mortgage interest, you may be able to deduct mortgage points from your taxes. Check with your tax accountant to find out for sure.
Potential Problems with Points
If mortgage points can save you money in multiple ways, then why doesn’t everyone purchase them? As Money Under 30 indicates, there are some potential downsides to buying points:
- Mortgage points add to the initial cost of your mortgage. Buying them will likely leave you with less cash after closing, and you may prefer to have a solid cash reserve in case of the unexpected.
- If you refinance or sell the home before you reach the break-even point, you won’t see any savings.
Is Purchasing Points a Smart Move?
Should you buy mortgage points? That depends on your situation and your priorities. According to SmartAsset, buying mortgage points may be beneficial if you have the money to pay for them and intend to retain ownership of the home for a long period. If purchasing mortgage points will create financial strain or drain your emergency fund, however, you may prefer to forgo mortgage points and refinance later. And if you plan to own the home for a short period, buying points may not pay off.
How long do you need to own a home to make the purchase of mortgage points worth it? If math was never your favorite subject, you may be more comfortable leaving the calculation to a mortgage calculator like this one from NerdWallet. However, it’s fairly easy to figure it out for yourself.
To calculate how long it will take to break even on the cost of the mortgage points and begin truly saving, you’ll need to calculate the difference between your monthly mortgage payment with no points and your payment with points. This will reveal your potential monthly savings. Then, you’ll divide the cost of the points by the potential monthly savings to discover how many months you’ll need to pay your mortgage in order to recoup their cost. If you plan to stay in the home longer than that period without refinancing, purchasing points should save you money over the life of your home loan.
At PrimeLending of Springfield, Missouri, we make finding the best mortgage for your needs simple. Whether you’re buying, refinancing, or eager to fund renovations, our personalized service, expert advice, and commitment to transparency eliminate unnecessary complications and allow you to feel confident in your decisions. To learn more about our services or schedule an appointment to discuss your homeownership goals, contact us today.