Whether buying your first home or considering refinancing, it’s important to understand mortgage points.
Mortgage points enable you to secure a lower interest rate when buying a home. Moreover, it results in long-term savings on your loan.
Our user-friendly guide will explain the calculation of mortgage points and help you determine if you need them.
What Are Points On a Mortgage?
Points on a mortgage or discount points are upfront fees paid to lenders at closing for a lower interest rate. Borrowers “buy down” the rate, reducing monthly payments long-term.
Each point costs 1% of the loan amount and lowers the rate by about 0.25%. Deciding to pay points depends on how long you’ll stay and cost-effectiveness.
How Much Do They Cost?
The cost of mortgage points typically amounts to 1% of the total loan amount. For example, if you have a loan of $200,000, one point would cost $2,000.
It’s important to note that the actual cost can vary depending on the lender and specific loan terms.
How Do Mortgage Points Work?
When you pay points, your interest rate decreases compared to a zero-point loan offered by the same lender.
A loan with one point typically has a lower interest rate than a loan with zero points on a similar type of loan.
Furthermore, a loan with two points from the same lender would have an even lower interest rate than a loan with one point.
Lowering the interest rate reduces monthly payments, but remember the upfront cost. Generally, the longer you stay in the home, the greater the benefit of paying for points.
The Benefits Of Mortgage Points
Mortgage points can be an excellent investment for certain homeowners. Evaluate the benefits and drawbacks before investing.
- Lower interest rate: Mortgage points allow you to secure a reduced interest rate on your loan.
- Long-term savings: By paying points upfront, you can potentially save money over the life of your mortgage.
- Lower monthly payments: A lower interest rate results in decreased monthly mortgage payments.
- Cost-effectiveness: The decision to pay points depends on factors like how long you plan to stay in the home and whether the upfront cost justifies the long-term savings.
- Customization: You have the flexibility to choose the number of points you want to purchase, allowing you to tailor the cost and savings to your specific needs.
Drawbacks
- Upfront cost: Purchasing mortgage points requires paying upfront fees, which can be a significant expense at closing.
- Break-even period: It takes time to recoup the upfront cost of mortgage points through monthly payment savings. The break-even period can range from several years to a decade or more.
- Uncertain future: If you sell your home or refinance before reaching the break-even point, the benefits of paying points may not be fully realized.
- Cash flow impact: Paying upfront fees for points reduces available cash for other immediate expenses or investments.
- Opportunity cost: The money used to pay points could potentially be invested elsewhere to earn a higher return.
What is Breakeven Point?
The breakeven point occurs when the savings from reduced monthly payments offset the upfront cost of mortgage points.
It represents the time needed to recover the initial expense and start benefiting from paying points.
The breakeven period varies based on factors like point cost, interest rate reduction, and monthly savings.
Breakeven Point Example
To calculate the breakeven point, let’s consider a loan of $400,000 with an interest rate of 3.2% and the purchase of 3 discount points. Assuming each point costs 1% of the loan amount, the upfront cost of the points would be $12,000.
By buying 3 points, the interest rate reduces to 2.45%. Using a mortgage calculator, we find that the monthly payment at the original rate is around $1,732, while at the reduced rate, it becomes approximately $1,592.
This results in a monthly savings of $140. To reach the breakeven point, we divide the upfront cost of $12,000 by the monthly savings of $140.
The breakeven point is achieved in approximately 85.7 months, or about 7 years and 2 months.
Mortgage Points Can Save You Money
Mortgage points offer a great opportunity for borrowers to save money in the long run by securing a lower interest rate. By paying upfront fees, you can actively reduce the interest rate, resulting in substantial savings over time.
It is crucial to assess your individual circumstances, considering factors such as your projected duration of homeownership, to determine if purchasing discount points is a beneficial choice.
Unlock the potential for significant financial savings and enjoy a more affordable mortgage experience throughout the years to come!
Frequently Asked Questions
1. When not to buy mortgage points?
Avoid buying mortgage points when you plan to sell or refinance before reaching the breakeven point. Similarly, if you lack the upfront funds and prefer lower closing costs, skipping points may be beneficial.
2. How many points can you put on a mortgage?
You can typically purchase up to three points on a mortgage, but some lenders may allow for more. The number of points you can buy may vary based on the specific lender and loan terms.
3. How mortgage points differ from mortgage origination points?
Mortgage points and mortgage origination points differ in their purpose and how they are applied. Mortgage points are upfront fees paid to lower the interest rate, while origination points are fees charged by the lender for loan processing services.
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