Mortgage points, sometimes called discount points, are fees that you pay in exchange for a lower interest rate. The common reason that people "buy down the rate" is that the lower interest rate may lower their monthly mortgage payment.
Calculating the cost of a point is fairly simple. One point equals 1% of the total loan amount. For example, if your loan amount is $120,000, then one point would cost $1,200, and you would pay this amount at closing.
Paying an additional $1,200 might sound counter-intuitive, but there are several instances where this makes the BEST sense. Here's how we figure out if buying mortgage points is a smart move.
The first thing you should know is that buying mortgage points is a "long-term" game plan. In other words, if you plan on staying in your home for less than 5 years, then buying points may not be the best move. The reason is that points help you to save over the life of the loan --so the longer you have the loan, the more you end up saving!
While there is no limit to the point you can buy, there are limits as to how much you can pay in closing costs. These limits vary state by state.
Remember that paying for points saves you money over the life of the loan. However, you also want to consider the "break-even" point, that is, the period where the fees you paid upfront equals the amount you are saving on your monthly mortgage payment.
So, for example, in a $150,000 loan at a rate of 4.99% for 30 years, paying $1,875 for 1.25 points and lowering the rate to 4.75. The monthly mortgage payment would be reduced by about $22 and would result in nearly $8,000 in savings over the life of the loan.
In this example, the break-even point would be right about year 7. So paying for points in this situation would make sense if you plan on living in the home for more than 7 years.
Here is another example using the same 30-year loan:
If you were to pay $2,625 for 1.75 points, this would reduce your monthly payment by about $45 and save you nearly $16,000 over the life of the loan. The break-even point in this example would be in year 5.
Although there are other variables to take into consideration, you can see how points work to save you money as well as why it makes sense only if you plan on staying in your home for several years.
Mortgage points are considered a pre-paid interest and may be tax-deductible. Talk to your tax preparer for more information on the tax benefits of buying mortgage points.
During your mortgage process, you might hear about both mortgage points and origination points. It's important to remember these two phrases refer to two different points. Mortgage points are a fee you pay to lower your interest rate. Origination points are a services fee that goes to your mortgage professional.
This is just the tip of the iceberg when it comes to the factors of buying mortgage points. If you want to find out if it makes sense in your situation, please contact us! We'll look at the big picture, from every which way, and guide you through the most affordable mortgage option for you and your goals.