What Every Borrower Must Know About Mortgage Points
Mortgages can be confusing.
There are loan terms, interest rates, down payments, closing costs, and many other detail that you need to understand in order to get the best results. Another important detail is the option for “mortgage points.”
While they are not offered by every mortgage company, and may not be right for every borrower, points can be beneficial for specific borrowers in certain situations. Depending on the length of your loan and the total down payment, they may be the right option for your specific needs.
Mortgage Points: What They Are and How They Impact Your Loan
In general, you will find that mortgage points come in two varieties; understanding both will help you make the right decision for your loan.
Remember that regardless of type, each point is equal to 1% of your mortgage amount. This means that if you borrow $500,000, for example, a mortgage point is equal to $5,000. When getting the loan, your lender may ask for you to pay points to cover the costs of the loan, however, you may be able to negotiate the removal of these requirements.
Discount Mortgage Points
The first type to understand are discount points. These are the most common, and they essentially function as prepaid interest. Depending on the loan, your mortgage may have one or several points, and you can either pay these up front or have your lender roll them into the full loan amount, which means you pay less upfront but have a larger monthly payment. The advantage is that when you pay points, you lower your interest rates. How much it will lower will change, but you’ll usually find that one point is worth about a quarter of a percentage on your interest.
Discount points can be deducted from your taxes as mortgage interest, assuming you’ve itemized the deductions.
This type of mortgage point usually only applies to mortgages on rental properties, so you’ll want to check with a tax professional to make sure you can deduct these points from your taxes. These are points that cover the lender’s costs for processing the loan, and they are a way to pay for your closing costs to make the loan more affordable upfront. The amount of points that a lender will charge will vary depending on the loan, so you’ll want to talk with the lender about specific details. Just remember that they are points that you will use on the origination, or creation, of your mortgage.
When is it a Good Idea to Pay Mortgage Points?
Paying points towards your mortgage can be a great idea, but they are generally used only in very specific situations. In most cases, it’s best to use points only when you plan on living in the home for an extensive period and have the money upfront to pay for the points..
For example, say you have a 30-year fixed-rate mortgage loan worth $250,000 with an interest rate of 4.5%. In this case, your monthly payment would be about $1,260 and you would end up paying over $450,000 through the life of the loan. However, if you take that very same loan and pay two mortgage points (about $5,000 for two points), which would reduce your interest rate by about .5%. With this addition, you would have monthly payments around $1,194 and you would pay about $430,000 through the 30-year period.
If you stay in the home for an extended period (such as the entire 30 years), you would have savings of about $26,000, which would make the initial $5,000 investment worth every penny.
To summarize, if you plan on staying in the home for a long time (at least roughly a decade but preferably more) and you have the money on hand to purchase them, mortgage points can be extremely beneficial to your mortgage costs.
When is it a Bad Idea to Pay Mortgage Points?
Not all situations will justify mortgage points. Let’s revisit our earlier example of a $250,000 loan on a 30-year fixed-rate structure with 4.5% interest. If you stayed in the house for 30 years, the two points you purchased would create savings of $26,000. However, if you stay in the house for a short period, the savings won’t come as easily; it would take you about five years and nine months to break even, which means if you stay in the house less than that, you’d essentially be losing money; even if you go slightly over that timeframe, the savings would be minimal and may not be worth the hassle or the initial investment of $5,000.
You also have to consider whether or not you can afford to pay for the points at closing. If you struggled to save for a down payment, the additional sum for points can be extremely difficult to generate and it may not be an option based on your budget. Your lender may allow you to roll them into your payment, which could reduce the initial costs and make points available to you. If this happens, however, you’ll be borrowing a larger sum and paying more, which somewhat negates the benefits of points.
In the end, it all comes down to basic math. You’ll want to get estimates from your lender on how much points will cost and how much they will lower your interest rates. Once you have these numbers, take the time to thoroughly measure the figures to see how long it will take to make the points beneficial to your long-term finances. If it seems like they will pay off long before you plan on leaving the home, then it could be the right option for your financial needs.
Helping You Find the Right Mortgage Options
Mortgage points can be complicated and confusing. If you are considering points for your mortgage, be sure to talk with a qualified professional who can help you understand all the details. Our team is ready to serve your needs, and we’ll be proud to help you make the right decision on your mortgage purchase!