When Discount Points Are Not Worth It
Now, take the same scenario as above. But imagine Steve decides he needs to sell that home two years after buying a $4,000 discount point.
After 24 months of being in that loan, Steve would have recouped less than $2,600 of his initial $4,000 investment. With such shortterm plans for his property, Steve is better off not increasing the costs of his loan with discount points and is better suited to take the higher original interest rate, says Killinger.
Bardos reminds us that one of the most important considerations for choosing a loan with points is the length of time you plan to remain in the home until refinancing or selling.
The longer the horizon, the more advantageous it is to prepay interest through points, Bardos says.
Consider, as well, that the cash required for points could often be better spent on paying off highinterest credit card or student loan debt, building an emergency fund, or investing in stocks, bonds, or other investment vehicles that can yield a higher rate of return.
This is especially true in our current low interest rate environment, when rates even without points are at historically low levels, Bardos says.
What Are Mortgage Discount Points
Mortgage discount points enable the reduction of your interest rate through payment of fees to the lender. For this reason, points are sometimes referred to as buying down the rate. By reducing your interest rate, you also reduce your monthly payment. One point is equal to one percent of your loan amount, so one point for a $360,000 loan would cost $3,600. Paying more upfront reduces your long-term costs, but like any financial decision, whether its the right move for you depends on your financial goals.Its important to note that the degree to which mortgage discount points reduce your interest rate depends on several factors, including your lender, the loan program you choose, and the mortgage market.
How We Got Here
To use the Should I buy points? mortgage calculator, type your information into these fields:
Desired loan amount
Interest rate without points
Number of points
Interest rate with points This shows what your rate would be if you paid for points. In general, lenders drop the interest rate by a quarter of a percentage point for each point purchased, up to a limit. But maybe a lender has offered you a rate thats different for buying this number of points. If so, type in that rate to ensure the accuracy of your results.
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The Benefits Of Mortgage Points
People buy points to lower their interest rate and save on the overall cost of the loan.
Points can increase your closing costs by thousands of dollars, but the large upfront cost might be worth it if you stay in the home long enough to see savings from the reduced interest rate. Paying an extra $2,000 upfront could mean tens of thousands of dollars in savings over the course of your mortgage. However, if you plan to sell your home or refinance before your break even, paying for points might not be worth it.
Points can also get you a lower monthly payment. If your monthly mortgage payment puts too much of a strain on your budget, mortgage points could be a way to save. A lower interest rate equals lower monthly payments.
You may even save money on taxes if you decide to purchase mortgage points. Since mortgage interest is tax deductible and points are considered prepaid mortgage interest, you may be able to deduct the cost of the points on your taxes. To understand the deductions you may be eligible for, check out the IRS rules on mortgage point benefits and speak with a qualified tax expert.
How To Shop For Loans With Mortgage Points
As of this writing, for instance, one national lender offers a 30year fixed loan at 4.5 percent with no points. You can knock .25 percent off that and get 4.25 percent by paying half a discount point.
But a 4.125 percent rate costs an additional point. Paying more doesnt necessarily get you a better deal.
When shopping for a mortgage with discount points, the easiest way to compare offers is to decide how much you want to spend, then see who offers the lowest rate at that price.
Alternatively, you can decide what rate you want, and see which lender charges the least for it.
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How Do Mortgage Points Work With Arm Loans
Mortgage points on an adjustable-rate mortgage work like points for a fixed-rate mortgage, but most ARMs adjust at five years or seven years, so its even more important to know the breakeven point before buying points.
Factor in the likelihood that youll eventually refinance that adjustable rate because you may not have the loan long enough to benefit from the lower rate you secured by paying points, says McBride.
How Much Do Mortgage Discount Points Cost
Typically, one point is equal to 1% of the loan’s principal, and it usually buys the rate down by 0.25%. So, you might have to pay four points to reduce your rate by a full percent.
Example. Say you buy one point on a mortgage loan of $300,000, which costs $3,000 . The initial interest rate was 3%. Because each point lowers the interest rate by 0.25%, buying one point lowers your mortgage interest rate from 3% to 2.75%.
But one point might reduce the rate by more or less than 0.25%, depending on the loan and lender.
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A Historic Opportunity To Potentially Save Thousands On Your Mortgage
Chances are, interest rates won’t stay put at multi-decade lows for much longer. That’s why taking action today is crucial, whether you’re wanting to refinance and cut your mortgage payment or you’re ready to pull the trigger on a new home purchase.
The Ascent’s in-house mortgages expert recommends this company to find a low rate – and in fact he used them himself to refi . and see your rate. While it doesn’t influence our opinions of products, we do receive compensation from partners whose offers appear here. We’re on your side, always. See The Ascent’s full advertiser disclosure here.
How Much Does One Point Lower Your Interest Rate
One discount point usually equals 1% of your total loan amount and lowers the interest rate of your mortgage around one-eighth to one-quarter of a percent. But heads up: the actual percentage change will depend on your mortgage lender.
Is your head spinning yet? Well hang on, were about to do some math.
To help this all make sense, lets break it down. Suppose youre buying a $300,000 house. You have a 20% down payment and are taking out a 30-year fixed-rate conventional loan of $240,000 at a 4.5% interest rate.
To lower the interest rate, you pay your lender for one mortgage point at closing, and assuming that point equals 1% of your loan amount, it will cost $2,400.
$240,000 loan amount x 1% = $2,400 mortgage point payment
After you buy the mortgage point, your lender reduces the interest rate of your mortgage by, say, a quarter of a percent. That takes your interest rate from 4.5% to 4.25%.
This slightly lowers your monthly payment from $1,562 to $1,526which is $36 less a month on a fixed-rate conventional mortgage.
You can use our mortgage calculator to figure the difference between the interest amount with the original rate and the interest amount with the reduced rate over the full lifespan of the loan.
Are you still with us? Okay, good.
Without any mortgage points, youll pay a total of $197,778 in interest. With one mortgage point, youll drop that amount to $185,035which saves you $12,743 in total interest.
|30-year loan amount: $240,000|
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How Much Down Payment
The amount of your down payment is another important factor in whether your should pay mortgage points. If you put down less than 20 percent of the cost of the house, your lender will require you to pay a monthly fee for private mortgage insurance to protect the lender in case you default on your mortgage. This PMI payment will offset some of the savings you get from paying points. It may make financial sense to use your money to make a bigger down payment and avoid PMI rather than to pay points.
How Do I Figure Out If Points Are Worth It
The answer comes down to whether you keep the mortgage past your “break-even point.” Thats when the money you save via your monthly mortgage payments reaches the amount you paid to buy points. After this time, you start saving money for real.
If you think youll refinance your mortgage or move before you break even, then you’ll lose money on the discount points you paid.
To figure out your break-even point, open the calculator app on your phone or computer.
Lets say you get a quote for a 30-year, $200,000 mortgage at a fixed 3%, and your monthly payment with no points is $975. You want to buy one mortgage point for 1% of the loan amount, or $2,000. It will allow your interest rate to drop to 2.75% and your monthly payment to fall to $954 saving you $21 a month.
Divide what you paid for your point by the amount of your monthly savings . The result is 95.24, which means it’ll take you 95 and a quarter months or just under eight years to hit the break-even point.
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Are Mortgage Points Tax Deductible
Source: Africa Studio/Shutterstock.com
Lets get the easy part of this question out of the way first: origination points are not tax-deductible.
However, since they actually represent prepaid interest, discount points are tax-deductible.
They can be deducted in the year taken, but the IRS has a list of nine conditions that largely eliminate that option. The main culprit being that discount points must be a typical charge in your market area. Thats almost certainly not true, since they are an optional charge paid at the discretion of the borrower.
In most cases, discount points will be deductible over the life of the loan. Thats because the benefits they provide apply over the entire loan term.
Additional Ways To Lower Interest Rates Or Costs On Your Loan
Buying mortgage points isn’t the only way to lower your mortgage’s interest rate or how much you pay in interest overall. Here are some additional options you’ll want to look into:
- Shop lenders and loan types. It can pay to get offers from multiple mortgage lenders, as each lender may have its own method for determining the interest rate it will offer you. Additionally, your rate could depend on the type of mortgage you get and whether it has a fixed or adjustable rate. Shop around to see which ones you’ll qualify for and which will be best.
- Increase your down payment. While you’ll need to come up with extra cash for a large down payment, doing so could lead to a smaller loan amount and lower interest rate. Putting at least 20% down can also help you avoid paying for mortgage insurance, which can lower your monthly payment.
- If you can’t afford a higher upfront cost but could take on a larger monthly payment, a shorter repayment term can lead to a lower interest rate.
- Find a less expensive home. Buying a cheaper house is another way to reduce your monthly payment and down payment amount.
Once you have a mortgage, you may be able to refinance to get a lower interest rate. Or, if your lender allows it, you could make bimonthly payments to decrease how much interest accrues overall.
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How To Figure Out If You Should Pay Points On A Mortgage
The best way to determine what makes sense for you is to calculate the total cost of each option over time.
To do this, estimate the amount of time you expect to be in your home. This will be the holding period youll use to calculate your payments.
If youre purchasing your forever home, you would want to calculate the full loan term . Perhaps this is a starter home, though. In that case, you might estimate that youll be in the home for seven years.
But also factor in the possibility that you might refinance sometime in the future. Mortgage points are non-refundable. If you refinance six months later, those funds are gone.
At a time like 2022 when rates have increased dramatically in a short time, theres a real possibility that rates will again fall in the next five years. If you stay in your home but refinance, points might end up being pointless.
How Points Work On A Loan
A point is an optional fee you pay when you get a home loan. Sometimes called a “discount point,” this fee helps you secure a lower interest rate on your loan. If you would benefit from a lower interest rate, it might be worth making this type of upfront payment. However, it may take several years to recoup the benefits of paying points.
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When Discount Points Are Worth It
Katherine Alves, executive vice president of Homeowners First Mortgage, says you want to ensure that purchasing discount points will result in a financial advantage.
To do so, you need to calculate the cost versus savings over time. This is done by comparing rates with no points to a loan with points and reviewing the overall annual savings in the monthly payment, recommends Alves.
Then, you need to decide if you are going to remain in your home or the current mortgage loan long enough to recoup the costs of your discount points, she explains. This is known as the breakeven point.
Take a look at an example.
Assume a borrower named Steve purchases a home and takes out a 30year mortgage for $400,000. Hes offered a 3.25% fixed interest rate.
- If Steve purchased one discount point a $4,000 upfront cost he would save about $108 on each monthly payment
- It would take Steve 37 months to reach his breakeven point and recoup the $4,000 he paid upfront
If Steve held onto the loan over its full 30year term, he would save around $35,000 overall in interest by purchasing that single discount point, Killinger says.
Here, the assumption is that Steve will stay put in his home and not refinance or sell until more than three years have passed. In this case, paying for a discount would be well worth it.
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What Are Discount Points
A discount point gives you the ability to buy a lower interest rate by pre-paying some of your loans interest. Each point will lower your interest rate by a fraction of a percentage.
Because interest is calculated based on a specific number of months that you will be making payments, reducing your interest rate by pre-paying interest may be a good idea if you are planning on keeping your mortgage for several years.
Are Points Right For You
You might be thinking that paying to get a low rate with tax benefits all sounds like a pretty good deal, particularly if you have the cash on hand to pay a little more at closing. It can be, but as with any transaction, there are pros and cons.
Coming up with that extra cash out of pocket at settlement is probably a solid choice if youre reasonably sure that youre going to remain in that home with that mortgage for decades. Youll obviously save much less if you move out or refinance in five years rather than run out the entire 30-year mortgage term. Otherwise, you might want to go ahead and pay a higher interest rate in exchange for some other lender concession or credit at closing.
The CFPB suggests comparing three scenarios: how much youll save if you were to sell or refinance in a few years, your savings if you were to remain in place with the same mortgage and monthly payment for the life of the loan, then again based on how long you honestly expect to live there.
Another option is to divide the dollar amount of the points youre considering paying by the monthly savings in interest. The answer will tell you how long you must stay in the home, with that mortgage, to reach the breakeven point where paying for points begins to make sense. Its expressed in months, so youd have to remain in the home without refinancing for almost eight years if the number you arrive at is 95. It works out to 7.91 when divided by 12 months in a year.
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