Mortgage Points: It Can Reduce Your Interest
Discount points or mortgage points are going to be paid directly to your lender at the time that you close on your home. The more points you pay for the lower the interest rate you’re going to have, which means you pay less per month.
A single point is going to cost you, however. You’ll have to pay 1% of your mortgage in order to get a single point. That means $1,000 for every $100,000 of your mortgage. Paying that money upfront, however, is going to help you lower the amount you’ll pay over time.
If you want to stay in a home you can absolutely save yourself some money by buying even more points. Just make sure that you’re paying attention to where you can get the best rate and how much you can save by buying points.
What Are Mortgage Points?
First, let’s take a look at just what points actually are and how you can use them to your own advantage.
First, a mortgage point is something that you buy during closing for your home to help you decrease the overall amount of your interest rate and monthly payment.
For a lot of people, this is actually referred to as buying down your rate because for each point that you buy you’re going to lower your interest rate by a set amount. This can be great for some.
Now, there are a couple of different ways that this work.
- Discount Points – Discount points are the ones that we’ve mentioned. You buy more points and decrease your interest rate slightly. Of course, your lender will set a limit on just how many points you can buy and how far you can decrease your rate. Overall, you should be able to get at least an eighth to a quarter of a percent off your total payment.
- Origination Points – These are the ones that are going to cover your actual costs when it comes to processing your loan. You want to negotiate with your lender to find out more about this process and get the most points you can/you want.
Using discount points will help you decrease your rate over time. For each point, you could end up decreasing your rate by an eighth to a quarter of a percent.
On a 30-year mortgage a single point generally decreases it by an eighth of a percentage point. On a 15-year mortgage a single point generally decreases it by a fourth of a percentage point.
You may need up to 4 points in order to decrease a 30-year loan by a single percentage point overall.
When It’s a Good Idea To Buy Points On A Mortgage?
Maybe you’re not sure about buying points at all for your mortgage.
Well, if you’re going to stay in your house for a longer period of time it might be a good idea to pay for points. You’ll save more money that way.
If you’re going to be there a while you’re going to save more by not having that extra percentage going toward interest.
Of course, you’re going to have to pay attention to how much it costs you upfront. If you can’t afford those points you’re not going to be helping yourself any.
When you do buy points though it’s actually considered tax-deductible, like paying interest on the property.
Pay attention to this as well when you’re looking at buying and then, consider what you could do with that money if you didn’t use it to buy points.
Those who aren’t planning on staying in the property for an extended period of time may actually lose money by paying for points.
At five years or less in a property, you’re going to pay more for the points than you would for that interest. That’s definitely not something you want to deal with and it’s a good reason to consider avoiding any points more than you’re required to have.
If you’re going to have trouble paying for everything you have to for that house at closing then paying for points is definitely not a good idea either. You’ll find yourself struggling to make the payment and actually close on the property.
That goes for paying more for your mortgage in exchange for the seller paying for the discount points. You’ll end up in more trouble in the long run.
What is Your Break-Even Point?
If you were to buy those points how long would it take for you to reap the benefits of having that lower interest rate?
At what point will you have saved more than you spent to buy the points? This is your break-even point and it’s an important aspect to consider.
Divide the cost of your points by the amount of money you’re saving each month by having a lower interest rate. That’s how many months you have to be there before you actually break even on what you spent.
How To Calculate The Break-Even Point?
What if you needed a $100,000 loan? Let’s say you’re offered a 4.5% interest rate on a 30 year loan and your monthly payments are set a $506 for principal and interest.
- One Point: One point, which would lower your payment by 0.25 of a percentage point means that you would come down to 4.25%. Your monthly payment would be $492 per month, which would save you $14 every month. Your breakeven for that, then, would be $1,000 (the cost of one point) divided by $14 (the amount of savings) which equals out to 71 months. 71 months divided by 12 months to a year means that you would need one month shy of 6 years before you would break even.
- Two Points: Two points, which would lower your payment by 0.50 of a percentage point, means that you would come down to 4% interest. The monthly payments would now be $477 and you would save $29 per month. Now we take that $2,000 for two points and divide it by $29. You end up with 69 months, which is 3 months shy of 6 years before you would break even.
- Four Points: Now let’s say you decide to go with a full 4 points. You want to lower your interest by a full percentage point and get your rate down to 3.5%. You would now be paying $449 a month and saving $57 a month. Now you need to divide $4,000 (the cost of 4 points) by $57 or the amount you’re saving and you would get 70 months. This means it would cost you 2 months shy of 6 years to break even.
|Monthly Payment Difference||Break-Even Point|
|1 point||$10 ($501-$491)||71 months (5 years, 11 months)|
|2 point||$29 ($501-$477)||69 months (5 years, 9 months)|
|4 point||$57 ($501-$449)||70 months (5 years, 10 months)|
There’s are some important factors to consider, however.
1. Your lender gets to decide how much of a discount you get when buying points (though each point has to be worth the same value).
2. Discount points on an adjustable-rate mortgage are good only for the introductory period at a fixed rate. You need to make sure that you’re getting enough value before the rate changes and it’s no longer valid. You want to make sure you’re going to save money before you stop getting the benefit.
Buying Points May Give You a Tax Benefit
Normally you would pay for your points over a mortgage’s lifetime. That means you would pay them in installments and this could allow you the ability to deduct them at tax time.
If you are using the mortgage for your primary residence then you may be able to deduct some of the money if you do it during the year that you took out thee mortgage and if you actually meet a few certain conditions.
You need to make sure that the points are amortized, but then you can talk with your tax preparer about your options.