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.
How To Calculate Mortgage Points
Picture this scenario. You take out a 30-year-fixed-rate mortgage for $200,000 with an interest rate at 5.5%. Your monthly payment with no points translates to $1,136.
Then, say you buy two mortgage points for 1% of the loan amount each, or $4,000. As a result, your interest rate dips to 5%. You end up saving $62 a month because your new monthly payment drops to $1,074.
To figure out when youd get that money back and start saving, divide the amount you paid for your points by the amount of monthly savings . The result is 64.5 months. So if you stay in your home longer than this, you end up saving money in the long run.
Keep in mind that our example covers only the principal and interest of your loan. It doesnt account for factors like property taxes or homeowners insurance.
Pros And Cons Of Paying For Points
One of the biggest advantages of mortgage points: They help to make the monthly payment more affordable, said Courtines. A lower monthly payment means youll not only have more cash flow to put toward bills or investments, but you might also have a better chance of qualifying for a loan in the first place.
The bank might say, You dont make enough money from your salary to pay $3,000 a month, but you do make enough money to pay $2,800 a month, Courtines explained. So you can make the loan smaller by paying points.
Of course, there are also the long-term savings. If you plan to stay in your home past the break-even point, you stand to save thousands of dollars in interest.
And there are tax benefits. Because mortgage discount points are considered prepaid interest, you can deduct the cost on your taxes as long as you meet the IRS requirements.
On the other hand, one of the drawbacks to paying points is youll need to have more cash at closing. If not, you have to roll that cost into the loan balance, which increases the ultimate price of the points because you end up paying interest on them.
The other big risk? You may not be in the loan long enough to earn back the value of the reduced interest rates, said Courtines.
Finally, you could get ripped off. You may think youre getting a great interest rate, said Courtines, but may have overcompensated the lender or mortgage broker by paying more points upfront than the amount theyre giving you back in lower rates.
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The Bottom Line: Mortgage Points Can Save You Money
Though mortgage points and prepaid interest may be right for some borrowers, they dont make financial sense for everyone. To determine whether you can save with discount points, you have to crunch the numbers. Sit down and assess your budget, down payment, loan terms and future plans before you close. Determine your breakeven point and your likelihood of staying in the home to understand if discount points will save you money in the long run when refinancing or buying a home.
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How Are Mortgage Points Factored Into Advertised Rates
Whether you find a rate on a mortgage lenders website or through a third party, the mortgage rates you see advertised might or might not include points. One rate might even seem attractively low, but that could be due to points already factored in that you might not want to pay. On Bankrate, we specify whether advertised mortgage rates include points so you can make a fair comparison between lenders.
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When Points Make Sense
If you plan to hang onto the mortgage longer than eight years, you’ll save money in the long run.
Discount points can be worthwhile when:
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You plan to stay in the home after your break-even point. Recouping the money you paid for discount points may take several years. But if you snagged an amazing interest rate and you dont have plans to move, then you’ll come out ahead.
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You need help qualifying for the mortgage. When you apply for a mortgage, the lender will calculate your “debt-to-income ratio,” or DTI. This metric shows how much of your monthly income will be going toward debt payments, including your mortgage. A DTI thats too high may disqualify you from the loan. But buying down your mortgage rate can help you lower your monthly payment and fit within the lender’s DTI requirements.
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You dont expect rates to drop much more. Paying money to lower your rate doesnt make sense if mortgage rates will keep dropping to new historic lows. People who bought their rate down three months ago regret it today” because rates fell soon after, Rueth says. But if you believe rates will start increasing soon, then you might decide it’s wise to buy down your rate.
But always shop around and seek out detailed rate quotes from three to five lenders or more. Because you might find one lender has a rate with no points that beats another lender’s rate with points.
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
What Are Origination Fees
Why do so many lenders quote an origination fee? To get a true no point loan, they must disclose a 1% fee and then give a corresponding 1% rebate. Wouldnt it make more sense to quote a loan at par and let the borrower buy down the rate?
The reason lenders do it this way is because of the disclosure laws in the Dodd-Frank Act. If the lender does not disclose a certain fee in the beginning, it cannot add that fee on later. If a lender discloses a loan estimate before locking in the loan terms, failure to disclose an origination fee will bind the lender to those terms.
This may sound like a good thing. If rates rise during the loan process, it can force you to take a higher rate. Suppose you applied for a loan when the rate was 3.5%. When you are ready to lock in, the rate is worse. Your loan officer says you can get 3.625% or 3.5% with the cost of a quarter of a point . If no points or origination charges show up on your loan estimate, the lender wouldnt be able to offer you this second option. You would be forced to take the higher rate.
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About Negative Points And Fractional Points
Negative discount points are an option a lender may offer to reduce closing costs. They work just opposite of positive discount points instead of paying money to receive a lower rate, you are essentially given money in return for a higher rate.
These are often a feature of “no closing cost” mortgages, where the borrower accepts a higher rate in return for not having to pay closing costs up front. This Mortgage Points Calculator allows you to use either positive or negative discount points.
Fractional points are commonly used by lenders to round off a rate to a standard figure, such as 4.75 percent, rather than something like 4.813 percent. Mortgage rates are typically priced in steps of one-eighth of a percent, like 4.5, 4.625, 4.75, 4.875 percent, etc., but the actual pricing is more precise than that. So lenders may charge or credit a fractional point, like 0.413 points or 1.274 points to produce a conventional figure for the mortgage rate.
Scenarios Where Buying Mortgage Points May Make Sense
Understanding how much points cost, the impact on your monthly payments and your break-even point is a good place to start. From there, you can consider your specific situation to determine if buying points is a smart idea.
Generally, buying mortgage points could make sense when:
- You plan on living in the home beyond the break-even point.
- You likely won’t benefit from refinancing your mortgage before the break-even point.
- Buying points won’t strain your finances.
However, if you need the cash for other expensessuch as moving, remodeling or monthly billsyou want to make sure buying points won’t leave you in a bind. Additionally, if you plan on selling the home soon, or you think you might refinance, the savings from buying a lower interest rate will be limited.
In fact, if you suspect you might not stick with the same mortgage for long, it could make more sense to ask for lender credits rather than buying mortgage points. Lender credits could basically be seen as selling points rather than buying them, because the lender pays you to accept a higher interest rate. It can make sense if you’re having trouble affording a down payment or the closing costs. Or if you suspect you may move or refinance soon.
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How Do Mortgage Discount Points Work
Mortgage points are one way to lower your interest rate. If you buy one point, it usually costs 1% of the loan amount so you would pay $2,000 to buy one point on a $200,000 mortgage. One point typically lowers your rate by 0.25%, so a 3% rate would fall to 2.75%.
But those are estimates. Theres no set price tag on points, and no hard-and-fast rules for how much they lower your rate. Thats why its important to “ask your lender about your spread of options,” Rueth says.
Get multiple rate quotes and ask each lender how its points system works.
If you see a spectacular mortgage rate advertised somewhere, look closely. The fine print might tell you that the rate comes with points. For example, the loans in the popular Freddie Mac mortgage rates survey often come with an average 0.7 point.
So, to get a drool-worthy rate, you may need to shell out an extra fee.
Any points should be listed on your loan estimate, an official document which the lender is supposed to provide at least three days before you close on the home loan. You pay points at closing, along with the other closing costs.
Bottom Line: Are Mortgage Points Worth It
In the end, lenders charge mortgage points because they hope to come out ahead on the deal. But that doesnt mean it cant be a win for you too.
Paying for mortgage points can get you into a home you would not otherwise be able to afford and save you money over time. Just be sure to crunch the numbers before signing on the dotted line.
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How Much Does A Discount Point Lower My Rate
Typically, one point lowers your interest rate by about a quarter of a percent. But that can vary by lender and situation.
The amount you can lower your interest rate will depend on:
- Your mortgage lender
- Your loan amount
- The number of points you purchase
For example, say you borrow $200,000 at a fixed interest rate of 3.0%. If you pay $2,000 upfront for one discount point, you may be able to buy your rate down to 2.75%, or 25 basis points. That would drop your payment by nearly $27 per month, notes Chuck Meier, senior vice president and mortgage sales director at Sunrise Banks.
However, he continues, your breakeven point would be 75 months to recoup the cost of the point you purchased, which would take just over six years.
In other words, buying mortgage discount points may or may not be worth it based on your financial situation and timeline.
Are Mortgage Points Worth It
Though money paid on discount points could be invested in the stock market to generate a higher return than the amount saved by paying for the points, the average homeowner’s fear of getting into a mortgage they can’t afford outweighs the potential benefit they may accrue if they managed to select the right investment. In many cases, paying off the mortgage is more important.
Also, keep in mind the motivation behind purchasing a home. Though most people hope to see their residence increase in value, few people purchase their home strictly as an investment. From an investment perspective, if your home triples in value, you may be unlikely to sell it for the simple reason that you then would need to find somewhere else to live.
If your home gains in value, it is likely that most of the other homes in your area will increase in value as well. If that is the case, selling your home will give you only enough money to purchase another home for nearly the same price. Also, if you take the full 30 years to pay off your mortgage, you will likely have paid nearly triple the home’s original selling price in principal and interest costs and, therefore, you won’t make much in the way of real profit if you sell at the higher price.
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What Are Mortgage Origination Points
Mortgage origination points are fees you pay to a lender for the processing of your home loan. These fees are how loan originators get paid.
Each point is 1% of the total loan amount. One point on a $200,000 loan would be a $2,000 charge. Because a single point has a higher total dollar value for a larger loan, you are likely to have more success negotiating smaller origination fees if you have a larger mortgage balance.
What Do Discount Points Cost
Discount points cost roughly 1% of the loan amount per point.
Purchasing the three discount points would cost you $3,000 in exchange for a savings of $39 per month. You will need to keep the house for 72 months, or six years, to break even on the point purchase. Because a 30-year loan lasts 360 months, purchasing points is a wise move in this instance if you plan to live in your new home for a long time. If, on the other hand, you plan to stay for only a few years, you may wish to purchase fewer points or none at all. There are numerous calculators available on the Internet to assist you in determining the appropriate amount of discount points to purchase based on the length of time you plan to own the home.
The second factor to consider with the purchase of discount points involves whether or not you have enough money to pay for them. Many people are barely able to afford the down payment and closing costs on their home purchases, and there simply isn’t enough money left to purchase points. On a $100,000 home, three discount points are relatively affordable, but on a $500,000 home, three points will cost $15,000. On top of the traditional 20% down payment of $100,000 for that $500,000 home, another $15,000 may be more than the buyer can afford.
Using a mortgage calculator is a good resource to budget these costs.
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Should I Buy Mortgage Points
Buying mortgage points and lowering your mortgage’s interest rate could be a good idea when you’re buying a home or refinancing your mortgage. However, doing so will lead to higher closing costs. Figuring out when buying down the rate makes sense depends on the cost, your financial position and your short-term plans.
Mortgage Points Explained: What They Are & How They Work
A common question for home buyers, especially first-time buyers, when they first see a loan estimate , is about mortgage points. Unless youre familiar with the mortgage industry, you probably arent aware of how mortgage points work or if they might make sense for your situation. Because your interest rate is impacted by the points included on your mortgage, its important to know the basics of what they are and how they work to fully understand the pros and cons.
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Should You Buy Mortgage Points
In general, mortgage points are a smart choice if you plan to be in the home for a while and are looking to build home equity. Before purchasing them, calculate the break-even point — or the point in time when you’d save more than those points cost. If you expect to still own the home around that time, then buying discount points is probably a good move.
You should also factor in your budget. If buying points would mean making a smaller down payment or diving deep into your emergency fund, it might not be the wisest choice. Having a flush emergency fund is critical for homeowners, as you never know when a repair might crop up.
