Taking out a mortgage comes with a slew of decisions to be made— which lender to go with, how much you should put down, whether you should get a 15-year or 30-year loan, and, of course, whether or not you should buy mortgage points.
Mortgage points, which you purchase at closing, can help you secure a lower interest rate over the course of your loan. Buying down your mortgage rate isn’t for everyone, and if you’re wondering whether mortgage points are worth the cost, we have some answers! Here’s a breakdown of how they work, how much you can expect to save, and their pros and cons.
How do mortgage points work?
Mortgage points, also known as discount points, are a fee paid at closing in exchange for a lower interest rate. The result of a lower interest rate is a smaller monthly payment and less money paid in interest over the life of the loan.
In general, for each point that you purchase, you will lower your interest rate by a quarter of a point. Typically, one point will cost 1% of your mortgage amount.
Say, for instance, that you take out a $300,000 loan with a 5% interest rate. One mortgage point would cost 1% of your $300,000 loan amount— so $3,000. That one point would lower the rate down to 4.75%. If you bought two points for $6,000, your rate would drop to 4.5% for the life of the loan.
Again, this reflects the general cost of a mortgage point. Be sure to check with your lender, however, because the terms of buying mortgage points can vary. Some lenders will also negotiate with borrowers.
How much do mortgage points save you?
If you do decide to buy down your interest rate, you’re probably wondering what savings you’ll see. How much you can save with mortgage points will depend on three factors:
- The size of your loan: If you have a larger loan, you will typically pay more in interest. Therefore, a borrower with a larger loan would stand to save more with mortgage points.
- The length of your loan: If you spread your mortgage payments out over 30 years, your loan will accumulate more interest than it would with a 15-year mortgage. Mortgage points can save you more money on a 30-year mortgage.
- How many mortgage points you purchase: The more points you purchase, the lower your interest rate will be, saving you more.
To make things easier for you, we’ve made a mortgage points calculator. Before you purchase any points, be sure to test a few numbers with this tool to see what can bring you the greatest savings.
How to Decide If Mortgage Points Are Right for You
First, you’ll want to be sure that you have the money needed to cover the cost of your mortgage points. Remember, you’ll be paying several other things at closing including your down payment and your closing costs. It might not be possible to pay another few thousand on top of these expenses.
Next, you’ll want to calculate what your break-even point is and think about how long you plan on owning your home. Your break-even point is when your total savings from your lower monthly payments exceed the upfront costs for the point. Oftentimes, this can take several years. If you plan on selling your home before the break-even point, buying mortgage points may not be the best move.
Similarly, you’ll want to consider the possibility of refinancing down the line. If you refinance before your break-even point, you’ll lose out on the future savings that you paid for.
It’s also important that you run the numbers to see if that money would be better spent on something else, like the down payment. Putting down a larger down payment can not only save you in interest, but if you can put 20% or more down, you will avoid paying for mandatory private mortgage insurance.
What are the pros and cons of mortgage points?
Here’s how all of this breaks down into mortgage points pros and cons.
Your monthly payment will be lower. A lower interest rate means a smaller monthly payment.
You’ll have to pay the upfront cost. Mortgage points aren’t cheap. You’ll have to put up the money for these upfront costs unless you have the option to roll them into your mortgage. Keep in mind that at closing, you’ll have to pay a bundle of other fees, as well as your down payment.
You can experience long-term savings. Mortgage points can save you by lowering the total amount of interest over the course of your loan. This amount can be significant.
There’s a period before you break even. You won’t start feeling the savings immediately. Even if your monthly payments are less, it can take years to finally reach the point where your savings outweigh the initial costs of the points.
You can deduct the cost of mortgage points from your taxes the year that you buy. If you are purchasing mortgage points for your primary residence, you can likely deduct the cost from your taxes. So even though you may have more upfront costs, you will benefit from a smaller tax burden in that year.
If you refinance with an even lower interest rate, the points are worthless. Say a few years down the line, interest rates drop significantly and you’re able to refinance with a lower rate. If you haven’t reached your break-even point yet, you’ll be losing out on money.
Putting the money somewhere else could potentially save you more. It’s always important to run the numbers before purchasing mortgage points to ensure that you’re putting money to its best use.
Put the Pencil to Paper
The most important thing to do when it comes to mortgage points is to put the pencil to some paper and do the math. Your local lender is available to walk you through all the potential savings and benefits, making sure you understand exactly what your options are. By knowing how much you stand to save or when your break-even point is, you can confidently make a decision that’ll save you when you purchase your home.