Understanding Mortgage Points you’re thinking about getting a mortgage, you might hear the term “mortgage points” or “discount points.” Understanding what these points are and how they work can help you save money on your loan. In this guide, we’ll explain everything you need to know about mortgage points and how they can be beneficial.
What Are Mortgage Points?
Mortgage points are fees that you pay to the lender when you close on your mortgage. These fees are paid upfront in exchange for a lower interest rate on your loan. One point usually costs 1% of the total loan amount. For example, if your mortgage is $200,000, one point would cost $2,000. By paying these points, you can lower the interest rate, which can save you money over time.
How Do Mortgage Points Work?
Mortgage points work like prepaid interest. When you pay points, you are paying some of the interest on the loan upfront. This lowers the interest rate, which reduces your monthly mortgage payment. Over the life of the loan, this can lead to significant savings.
For example, let’s say you have a 30-year mortgage for $300,000 with a 4% interest rate. If you pay two points, costing $6,000, your interest rate might drop to 3.5%. This lower interest rate means you’ll pay less in interest over the years, saving you a lot of money.
Types of Mortgage Points
There are two main types of mortgage points: discount points and origination points. Knowing the difference can help you decide what’s best for you.
1. Discount Points
Discount points are the points that lower your interest rate. For each discount point you buy, your interest rate usually drops by about 0.25%. This means the more points you pay for, the lower your interest rate and monthly payments will be.
2. Origination Points
Origination points are fees that you pay the lender for processing your loan. These points don’t reduce your interest rate; they are just part of the closing costs. Even though they don’t lower your payments, it’s important to factor these into the overall cost of the mortgage.
Should You Buy Mortgage Points?
Deciding whether to buy mortgage points depends on a few things, like your financial situation, how long you plan to stay in the house, and current interest rates. Here are some things to think about:
1. How Long You Plan to Stay in the Home
If you plan to stay in the house for a long time, buying points might be a good idea. The longer you stay, the more money you can save with a lower interest rate. But if you think you’ll move or refinance in a few years, paying for points might not be worth it.
2. Break-Even Point
The break-even point is how long it takes for the savings from the lower interest rate to equal the cost of the points. To find this, divide the cost of the points by how much you save each month. For example, if points cost $4,000 and you save $100 a month, it would take 40 months to break even. If you plan to stay in the house longer than 40 months, buying points could save you money.
3. Your Available Cash
Paying for points means you need to have extra cash available when you close on the mortgage. If you’re short on cash or have other debts to pay, it might be better to skip the points and keep your money for other needs.
4. Current Interest Rates
Interest rates can also affect whether buying points is a good idea. If rates are low, the savings from points might not be as much. But if rates are high, lowering your rate with points could save you a lot of money over time.
Tax Benefits of Mortgage Points
Mortgage points can also offer tax benefits. In many cases, you can deduct the cost of points on your tax return as mortgage interest. However, the rules can be tricky, so it’s a good idea to talk to a tax professional to see how buying points might affect your taxes.
Conclusion: Understanding Mortgage Points
Mortgage points can help you save money on your mortgage, but they aren’t right for everyone. The decision to buy points depends on your financial situation, how long you plan to stay in the house, and current interest rates. By thinking about these factors and calculating your break-even point, you can decide if buying points is the best choice for you.
