Purchasing a new home is a significant financial decision that requires careful planning and attention to detail. To get started on the right track, you should first determine the monthly payment you can afford before you start house hunting.
Next, homebuyers should devise a plan on how to achieve this payment amount, whether it’s by making a large down payment, buying a less expensive home, or purchasing mortgage points.
While most people understand those first two options – making a larger down payment or buying a less expensive home – not as many are familiar with mortgage points. However, they can be an extremely useful tool to help you save money, but you must understand how they work to know if they’re a good option for your situation.
In this article, we want to take a quick look at what mortgage points are, how they can help reduce your interest rate, and how to determine if it’s the best option for you.
Let’s dive in.
Mortgage Points Defined
Mortgage points represent fees paid to the lender at closing in exchange for a reduced interest rate (also known as ‘buying down the rate,” according to Investopedia).
Essentially, purchasing mortgage points allows you to prepay on your loan interest, which lowers your monthly mortgage payment.
While this sounds great – and it is for many homebuyers – it’s not a perfect solution for all homebuyers and depends on a few important factors.
Before discussing these factors, let’s first look at how exactly these points can reduce your interest rate.
How Does One Mortgage Point Reduce Your Interest Rate?
The amount of savings achieved through the purchase of mortgage points is entirely dependent on the interest rate, the amount borrowed, and the loan’s term. Each point is typically equivalent to 1% of the total amount mortgaged. As an example, if the total amount mortgaged is $250,000, then one mortgage point would cost $2,500.
For each point purchased, the lender typically reduces the interest rate by 0.25%. According to NerdWallet, “One point can reduce the rate more or less than that. There’s no set amount for how much a discount point will reduce the rate. The effect of a discount point varies by the lender, type of loan, and prevailing rates, as mortgage rates fluctuate daily”.
Should You Buy Mortgage Points?
Now, let’s look at whether or not this is the right option for you.
First, you must determine your “break-even point,” which is the number of years it will take before you’ve paid off the points you purchased and when you’ll start saving money from the lower interest rate.
Buying points is helpful if you’re purchasing your forever home, and you have enough cash upfront for both a large down payment, as well as enough leftover for lowering the rate. Ideally, you would keep the mortgage loan long enough to exceed the break-even point.
Keep in mind that the break-even point will vary, depending on the mortgage loan amount, interest rate, and term. That said, it’s generally true that purchasing mortgage points makes more sense the longer you’re planning to live in a home.
Purchasing Mortgage points may not be the best idea if you expect to sell your home or refinance before you hit the break-even point.
Ready to determine if purchasing mortgage points is right for you? There are plenty of calculators available to help you figure this out, such as the “Should I Buy Points” calculator from NerdWallet, here: https://bit.ly/2Jy9j7F.
As always, it’s essential to discuss the purchase of mortgage points with a qualified, local mortgage lender to ensure you’re making the best, most cost-effective decision for your unique situation.