Points of Interest
The answer to whether mortgage points are worth it can only be answered on a case-by-case basis. If you’re planning on staying in your home longer than the break-even point, you will see savings. If those savings surpass what you might get in outside investment, then mortgage points will undoubtedly be worth it.
When it comes time to buying a home, you have plenty of decisions to make concerning your mortgage. One of the questions that comes up often is whether mortgage points are worth it. While it’s true that mortgage points will lower your interest rate for the life of the loan, they may or may not be the best fit for you.
The determining factor generally is how long you plan to stay in the home. The longer you plan on living there, the better the chance that mortgage points will be worth it. With a mortgage calculator, you can determine precisely how long that is and whether or not mortgage points are worth it in your situation. Additionally, you do need to weigh in tax benefits, the availability of outside investments, and your cash on hand.
What are mortgage points?
Mortgage points, sometimes known as discount points, are an option to pay an upfront cost to your lender to lower the interest rate for the life of the loan. Generally, the cost of a mortgage point is $1,000 for every $100,000 of your loan (or 1% of your total mortgage amount).
Each point you purchase lowers your APR by 0.25%. For example, if your rate is 4% and you buy one point, your APR rate would go down to 3.75% for the life of the loan. Because your rate is lower, you will save a little bit on every one of your mortgage payments. Eventually, over time, those savings will increase and equal and surpass the amount you had to pay for the discount. This is known as the break-even point.
Mortgage calculators can help you determine exactly where that break-even point is. If you end up selling your home or refinancing before the break-even point, you’ll lose money on the mortgage points. If you keep your home longer than the break-even point, you’ll start to realize some savings. Keep in mind, though, that all other conditions remain the same. Many would argue that you have to also calculate the money you could have earned over that period by putting the money you spent on points in another form of investment.
Types of mortgage points
1. Origination points are a fee you must pay a bank or mortgage company to give you a loan (likely required by the lender).
2. Discount points (the focus of this story) lower the interest rate on your loan and reduce your monthly payments.
Mortgage points vs. origination points
Mortgage points give you the option to lower your interest rate and decrease your monthly mortgage payments. There are two types of these points: discount points and origination points.
Discount points are a form of prepaid interest that you can purchase to reduce your interest rate. Doing so will give you ongoing savings on your mortgage costs over a number of years.
Origination points are a fee paid to the lender that provides your mortgage for the evaluation, processing and approval of your loan. These also help lower the interest rate on your mortgage.
In most cases, you’ll pay a fee equal to 1% of the mortgage amount for each discount poinot.This fee is typically paid directly to your lender or as part of a fee package.
Who provides mortgage points?
Most lenders provide the option for homebuyers to purchase mortgage points, though they are not required to. Additionally, most lenders have a cap on the number of mortgage points you can buy. Generally, this is capped out around four or five points. Some lenders will let you purchase in increments, so you may not need to buy whole points if you’re looking for a more tailored fit.
Are mortgage points tax deductible?
Mortgage points may be tax-deductible, depending on whether you meet the criteria laid out by the IRS. You can deduct the points in the year that you pay them or throughout the life of the loan. While most people will be able to deduct mortgage points over the life of the loan, you must meet several specific criteria to deduct them all during the first year. These are clearly laid out on the IRS website.
How mortgage points impact your home loan
Example: compare two typical 30-year fixed-rate mortgages of $100,000
- Mortgage Option 1: 4% interest rate with no mortgage points
- Mortgage Option 2: 3.875% interest rate with 1 point
|Scenarios||Terms||Monthly Payment||Total Payments Over 30 Years|
|Mortgage 1||4%, No points||$477.42||$171,869.51|
|Mortgage 2||3.875%, 1 point||$467.38||$168,257.40|
Recouping the costs of mortgage points
If you pay 1 point, which will cost you $1,000 on a $100,000 mortgage (remember, each point costs 1% of your home loan amount) to get the 3.875% rate, you lower your monthly payments by about $10. That means it would take 100 monthly payments, or more than eight years, to recoup the upfront cost of that point. You won’t really start saving any money until then, and therein lies the problem.
Think about it: do you really plan to stay in your house for 30 years? And selling or refinancing before the break-even point means you’ll actually wind up paying extra interest on the loan.
Mortgage points may not be a smart financial move
Richard Bettencourt, a mortgage broker in Danvers, Massachusetts, and former president of the Association of Mortgage Professionals, says paying mortgage points typically isn’t a good financial move.
“The only way I see a point making sense is for that rarity of the person who says, ‘I’m going to make all 360 payments (on a 30-year home loan) and never move,’” he said.
What about having a home seller pay points to buy down your rate? Isn’t that a good deal for a buyer?
“Do you want the seller to reduce your monthly payment by $20 for the next 30 years or give you $7,500 to refinish the kitchen now?” Bettencourt said.
Another way to look at mortgage points is to consider how much cash you can afford to pay at the loan-closing table, says Mark Palim, vice president of applied economic and housing research for Fannie Mae, a government-owned company that buys mortgage debt.
“If you use up some of your savings toward prepaying your interest, which makes your payment lower on a monthly basis, you have less savings if the water heater breaks,” he said. “Does it make sense to put more of your savings into the transaction to lower the monthly mortgage payments?”
Are mortgage points worth it?
They could be, but it will depend on whether you plan on selling or refinancing your home before you’ve paid it off. If you know you’re in your home for the long haul, you might reap the benefits of lower monthly mortgage payments for the next few decades.
On the other hand, mortgage points probably aren’t worth it if you’d be using a big chunk of your savings to buy them. Lowering your monthly payments by a small amount doesn’t quite make sense if you’d have to sacrifice your emergency fund to do it — especially if you’re not committed to staying in your home for the next 30 years.
The final word
In short, the answer to whether mortgage points are worth it can only be answered on a case-by-case basis. If you’re planning on staying in your home longer than the break-even point, you will see savings. If those savings surpass what you might get in outside investment, then mortgage points will undoubtedly be worth it.
Additionally, you should factor in the need for capital to purchase mortgage points. When you buy a house, you have to pay for many things like the down payment, closing costs, moving costs and more. For many, tacking on several thousand dollars more to realize savings years down the road is not feasible. For many, people planning on staying in their home for a long time might be worth it.