For many people, their home is the largest item they will ever buy. It’s critical that you are thoughtful with your home purchase, that you get the best possible price, and that your interest rate is as low as possible.
You need to understand all potential advantages and use the benefits, tools, and strategies that are right for you.
Although they are not perfect for everyone, the use of mortgage points can save thousands of dollars.
What are Mortgage Points?
“Mortgage points” is an industry term that describes a lump-sum payment at the beginning of a mortgage to reduce interest over the lifespan of a loan. Instead of having a higher interest for 15 or 30 years, you pay upfront for a lower rate throughout the loan.
In many ways, it’s like pre-paying interest. It’s often the ideal choice when you plan on staying in the home for an extended period.
In general, there are two types of points you can purchase…
Discount Points
With discount points, each point you purchase will lower the overall rate by a certain percentage, which is agreed upon before starting the loan. Normally each “point” reduces the rate by 0.25%, but this can vary. The price of each point depends on many factors, including the overall size of the home loan.
Origination Points
Processing a mortgage costs money. However, your lender may offer points to reduce the principal amount. Origination points are less common, as many groups offer no-fee mortgages or a flat fee.
For the most part, we will be discussing discount points, not origination.
How do They Work?
The discount points you purchase at the beginning go towards reducing the future mortgage interest, thereby reducing the payment total.
As we said, one mortgage point usually reduces the interest by about a quarter of a percentage. Imagine you want to take out a 30-year mortgage worth $500,000 at a fixed rate of 4.25%. However, you purchase two mortgage points, spending roughly $10,000 to reduce the rate.
With these numbers, you would spend $10,000 at the beginning, but by the end of the mortgage (30 years later), you would have saved about $51,000. With these numbers, you would be at the break-even point (the point when your expenses are recovered in savings) in roughly five years and ten months. After that, you would be saving money on the mortgage.
Want to see how mortgage points impact your loan? Experiment with our Points Calculator to see different costs, savings, and interest reductions.
What is the Cost?
The final price for each mortgage point varies by lender. It’s best to contact the professional who will oversee your mortgage to fully understand the final price.
To find out when you’ll start recouping money, you need to find out the total cost and compare that to how much you will save each month.
When to consider Mortgage Points
Mortgage points can be used in just about any situation, but here are a few indications that you should spend a little more now to have a lower interest later…
You Have the Cash Upfront
This is, of course, a prerequisite. If you have the cash in a bank account and can reasonably afford the mortgage points, without creating a financial struggle, it may be good to purchase the points. If you don’t have the money, or if the cost would create a tight budget, perhaps you should save the cash.
You Will Keep the Mortgage for Many Years
Mortgage points only make sense when you will keep the mortgage for a long time. If you plan on keeping the mortgage and paying it off in full, if you plan on owning the home for a long time (whether you live in it or not is, essentially, inconsequential to this point) you may benefit from using mortgage points.
Usually people break even around four to six years, depending on how many points are purchased. Therefore, if you will sell the property and pay off the mortgage within a few short years, you probably won’t benefit from purchasing mortgage points.
You Won’t Be Able to Refinance Soon
If you can refinance the mortgage and get a lower interest rate soon, purchasing points may not be worth the cost. Many people can improve their credit rating and lower their debt loads, which could mean a lower rate.
If improvements to your financial situation can be expected, and these improvements could result in better credit, then perhaps it would be best to wait.
Other Factors Won’t Lower Your Rate
Let’s suppose you need a low interest rate on your mortgage, but because of your debt load and poor credit, you can only get a high interest rate. In this case, it may be beneficial to purchase mortgage points, as these could be the only option for reducing your interest.
For many buyers, good credit and a low DTI can support a low interest rate. If this is not the case for you, purchasing mortgage points may be the best choice.
There are many factors to consider. Before you purchase mortgage points, think about your situation and the years ahead. Do you plan to spend a decade or more in the home? Will you pay off the mortgage early, and thereby avoid most of the interest? Do you have the cash and can use it without creating a financial strain? It’s important to ask these questions and be completely honest when you are considering mortgage points.
Summary: Consider mortgage points if…
- You have the cash on hand
- You will keep the home for a decade or more
- You don’t expect to refinance
- You can’t get a low mortgage through other means
Get the Lowest Rate Possible on your Next Mortgage
You deserve the most affordable mortgage possible. Contact our team today and let up help you find the right financing for your next purchase. Whether you want a large country home or an elegant downtown condo, we’ll help find the most affordable mortgage on the market.
