Introduction
Mortgage points, also known as discount points, offer a unique way for homeowners to lower their monthly mortgage payments. Getting paid for points at the closing may lower your interest rate and translate into thousands of dollars of savings over the life of the loan. But mortgage points are not for everyone and one must know when it is financially beneficial. In this article, you will learn what mortgage points are, how they work, and a few things to consider when deciding if purchasing points is right for your home loan with Beach Community Mortgage.
What Are Mortgage Points?
Mortgage points are prepaid costs for getting a lower interest rate on your loan, paid at the time of closing. In other words, you are paying some interest in advance and get a lower rate when you purchase points. This process is usually referred to as the ‘buy down of rate’ because it ‘buys down’ the interest that you will be charged on the loan.
Normally, one point will cost one percent of the total loan amount. For instance, where you have a mortgage of $300,000, one point would be worth $3,000. This usually reduces the interest rate by approximately 0.25%, though the specific reduction depends on the lenders and loan products. Reducing your interest rate, therefore, mortgage points decrease your monthly payment and the total interest paid within the life of the loan.
Types of Mortgage Points
Discount Points
Interest rate buydowns are bought for the purpose of lowering the interest rate on your mortgage. These are the most typical kind of points paid for by borrowers who intend to live in their homes long enough to reap the benefits of the lower interest rate.
Origination Points
Origination points, on the other hand, are charges which are paid to the lender in relation to the cost of preparing the loan. While the origination points are not like the discount points that reduce your interest rate, it is still worthwhile to use them if you need to pay some amount of money for some specific operations connected with the given loan.
How Mortgage Points Work
When you buy mortgage points, you’ll pay an additional fee at closing. In return, your lender will lower the interest rate on your mortgage, resulting in lower monthly payments. The amount by which your interest rate is reduced varies by lender, so it’s essential to consult with a mortgage specialist at Beach Community Mortgage to understand the exact rate reduction you’ll receive.
Let’s say you’re financing a $300,000 home with a 30-year fixed-rate mortgage at an interest rate of 4%. Without points, your monthly payment would be approximately $1,432. By purchasing one point for $3,000 and reducing your rate to 3.75%, your new monthly payment would be about $1,389, saving you $43 per month.
The Break-Even Point: Is It Worth It?
To determine if buying points is financially worthwhile, it’s important to calculate the break-even point. This is the amount of time it will take for the savings from a lower monthly payment to exceed the upfront cost of purchasing points.
Using the previous example, if you paid $3,000 for one point to reduce your interest rate and saved $43 per month, your break-even point would be approximately 70 months, or just under six years ($3,000 ÷ $43 = 69.8). This means you would need to stay in your home for at least six years to benefit from the lower rate. If you plan to move or refinance before reaching the break-even point, buying points might not make financial sense.
Pros of Buying Mortgage Points
Lower Monthly Payments
By reducing your interest rate, mortgage points lower your monthly payments, freeing up money in your budget. This can be particularly helpful for first-time homebuyers or anyone looking to reduce housing expenses.
Long-Term Savings on Interest
Lowering your interest rate with mortgage points reduces the amount of interest paid over the life of the loan, which can translate into significant savings, especially on a 30-year mortgage.
Tax Deductibility
In many cases, mortgage points are tax-deductible as prepaid mortgage interest. This means that, depending on your tax situation, buying points could provide additional financial benefits at tax time. However, it’s best to consult with a tax professional to understand how this might apply to your specific circumstances.
Flexibility in Rate Reduction
With mortgage points, you have some control over your interest rate. This flexibility allows you to “customize” your mortgage to fit your long-term financial goals, providing an opportunity to save more in the future.
Cons of Buying Mortgage Points
High Upfront Cost
The main downside of mortgage points is the initial expense. Buying points requires a larger upfront payment at closing, which might not be feasible for every borrower. If your budget is tight, you may prefer to use these funds toward other costs, like a higher down payment.
Delayed Financial Benefit
Mortgage points are most beneficial for homeowners who plan to stay in their homes long term. If you sell or refinance your home before reaching the break-even point, you won’t fully realize the benefits of the lower rate.
Opportunity Cost
Spending thousands of dollars on points means you’ll have less cash for other financial priorities. For example, you might be better off investing those funds or using them for home improvements that increase your property’s value.
Not Ideal for Short-Term Homeowners
If you don’t plan to stay in your home for several years, the benefits of purchasing points diminish. In such cases, it may be wiser to opt for a loan without points and focus on paying off your mortgage faster if possible.
When Buying Points Makes Sense
- You Plan to Stay Long-Term:
Mortgage points are best suited for homeowners who plan to stay in their homes for the long term, as the savings accumulate over time.
- Current Interest Rates Are High:
If interest rates are relatively high, buying points to secure a lower rate can provide a more noticeable financial advantage.
- You Have the Cash for Points:
If you have enough cash on hand for the upfront cost and want to save over time, purchasing points can be a smart financial move.
- You Want to Maximize Tax Deductions:
Mortgage points may be deductible, so buying points could offer additional savings at tax time.
When to Avoid Mortgage Points
- Short-Term Homeownership Plans:
If you’re likely to sell or refinance in the near future, the break-even period may be too long to justify buying points.
- Limited Cash Reserves:
If you’re stretched thin with closing costs or other expenses, using funds to buy points may not be the best option.
- Low Initial Rates:
In some cases, rates may already be low, making the savings from points less significant. It may be more effective to focus on a larger down payment or other cost-saving strategies.
Bottom Line
Mortgage points offer a valuable way to reduce your interest rate and lower monthly payments, making them an attractive option for long-term homeowners. However, it’s essential to consider your budget, future plans, and the break-even period to determine if points are the right choice for you.
If you’re considering buying mortgage points or have questions about how to optimize your mortgage, reach out to the experts at Beach Community Mortgage. We’ll provide the guidance and support you need to make an informed decision that benefits your financial future.