If you want to lower the interest on your next home loan, mortgage points can be extremely useful. They might seem complex, but the basic principle is simple: mortgage points are upfront payments that reduce the interest rate. Basically, you pay a little more at the beginning and the interest rate on your loan is reduced.
Usually, a mortgage points costs 1% of the loan itself, and it results in a .25% reduction in interest. So if the loans is for $500,000 and the interest rate is 4.25%, one “point” would cost $5,000 and it would reduce the interest to 4.00%.
Also known as “discount points,” they can be beneficial on your next loan but you need to consider many factors before making a decision. While there is no perfect formula for all borrowers, there are a few situations that increase the chances of mortgage points being useful for you.
When to Use Mortgage Points on a Home Loan
Each person’s situation is different, but there are some unique situations that indicate using mortgage points may be beneficial. While you need to consider your personal situation, if you meet one or more of the following factors, purchasing mortgage points may be a wise choice…
When You Will Own the Home for a Long Time
The largest indicator for whether or not you should purchase mortgage points is the length of time for which you expect to own the home. If, for example, you only plan to own the house for a decades, it may not be useful to purchase discount points. But if this is going to be your “forever home,” the house that you plan to stay in possibly beyond retirement, purchasing discount points may be worthwhile.
Of course, predicting the future is impossible, and people’s plan change rapidly. A new job, a decision to attend school, or changes in the family can all change your decision. But generally speaking, if this will be the lifelong house for you, it may be worth purchasing discount point.
To be fair, mortgage points have more to do with the life of the loan than how long you live in the house, but the two are clearly connected.
While you need to consider the future, there are also factors rooted in the present.
When You Have the Money in Savings
It seems like an obvious point, but it needs to be said: in order to use discount points, you should actually have the money on hand, and using this money should not create a significant decline in your financial situation.
First of all, you should avoid borrowing money to pay discount points. Yes, you can likely find a credit union or bank that may be willing to lend money for a variety of purposes, but in this case you are going to pay interest on the money borrowed, so any savings from the discount points will likely be negated; it’s even possible to lose money in this situation, so only pay for discount points out of pocket.
Also, your financial situation should not be significantly altered by using discount points. If you have to avoid making investments, purchasing a vehicle, or have to scrimp and save to gather enough for discount points, it may not be worth it. Basically, you should not make financial sacrifices to pay mortgage points; they should be something you can comfortably afford.
You Can Pay for the Downpayment AND the Mortgage Points
Generally speaking, if you have the opportunity to make a larger downpayment or purchase mortgage points, it’s usually recommended that you go with the downpayment. If you only have the money for one or the other, it’s best to use it towards a downpayment, which reduces your debt load and lowers the overall payment on the loan.
Basically, you should use mortgage points after you have a fully-funded downpayment. (What counts as “fully funded” depends on too many factors to describe here, so talk with your lending agent.)
You are Using a 30-Year Loan
As we discussed earlier, the length of the loan, and not necessarily how long you live in the house, is the factor that really matters. After all, you could live in the house for 60 years, but only pay on the mortgage for five; they are two very different numbers.
Most people will use a 30-year mortgage on their home. The other common length, although less popular than 30 years, is 15. Generally, someone using a 30-year mortgage will benefit more from using discount points. If you are using a 15-year mortgage, it may be best to simply add the additional cash, the money that you would have used on the mortgage points, to your downpayment.
You Don’t Expect to Refinance in the Near Future
This is tied to the length of the loan. Investing in discount points is only useful if you will be making payments for an extended period, so if you honestly expect that you will refinance in the near future, it’s probably not worth the effort. After all, if you refinance, the loan is gone, so any long-term savings (mortgage points are a long-term strategy) would be lost.
Hint: Look for the “Break-Even” Point
When trying to calculate the advantage of mortgage points, it’s best to look for the time when you will recoup the money you paid. This is the so-called “break-even” point and it’s a way to figure whether or not the points are worth the price.
Basically, you want to find the monthly amount you will save from using discount points. Once you know the amount, you should calculate how many months it will take to equal the total amount you paid upfront. If the break-even will come after 20 years, and the mortgage is for 30 years, it may be worth the investment into mortgage points.
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