Are Mortgage Points Worth It?
Whether you’re a first-time homebuyer or just haven’t gone through the process in a while, you may be wondering what mortgage points are and if paying for points is worth the cost.
Paying points on a mortgage can lower your interest rate, which reduces your monthly payments over the life of the loan. However, you’ll have to pay more upfront, and it may or may not be beneficial, depending on how long you stay in your home. To make the right decision, it’s important to understand how mortgage points work, their pros and cons, and how to perform a simple break-even analysis to calculate points on a mortgage and determine when you could expect to see a return on your investment.
What Are Mortgage Points?
Mortgage points are fees that you may pay your lender upfront (at closing) in exchange for a reduced interest rate on your home loan. Typically, one point equals 1% of your loan amount and reduces your interest rate by about 0.25%. So, if your loan is $200,000, one point would cost $2,000. You can usually buy fractional points, too (e.g., a quarter point for $500).
Paying mortgage points is sometimes called buying down the rate or buying points. You may also hear mortgage points referred to as discount points – but don’t confuse them with origination points, which are administrative fees that lenders charge to set up your loan.
How Do Mortgage Points Affect Your Interest Rate?
For each point you buy, your mortgage interest rate will be reduced by a certain fraction of a percent. The exact amount will vary from lender to lender, but you can generally expect a reduction of one-quarter of a percent per point.
For instance, if you’re looking at a 30-year fixed mortgage with an interest rate of 5.500%, purchasing one point might reduce your rate to 5.250% for the entire loan term. A quarter of a percent might not seem like a lot, but it can add up to substantial interest savings over a period of years.
Pros of Buying Mortgage Points
There are many potential advantages to mortgage points. Buying mortgage points can allow you to:
- Lower your monthly payments, which can be helpful for your household budget
- Save on the total cost of your home by reducing the compound interest you’ll pay over the life of the loan
- Qualify for a loan if your income or your credit score is too low, but you have cash available to buy points
- Deduct some or all points from your federal income taxes in the year you pay them, if it’s your primary residence and other conditions are met. Consult your tax advisor.
Cons of Buying Mortgage Points
Mortgage points have their drawbacks, too. Before you buy mortgage points, consider that you may:
- Give up too much liquid cash, which could reduce the funds you have available for home repairs, moving costs, emergency savings, and other important expenses
- Miss out on the benefits of making a bigger down payment instead, like avoiding private mortgage insurance (PMI) that is usually required when you put down less than 20% of the loan value
- Get a discount only during the initial period of an adjustable-rate mortgage (ARM), depending on your lender and your specific loan terms
- Ultimately lose money if you sell your home before you reach a break-even point
How to Perform a Break-Even Analysis
Because mortgage points are a matter of paying now and saving over time, it’s very useful to know when exactly you’ll recoup the initial cost and start enjoying a return on investment.
With our free online mortgage calculator – or even the back of an envelope – you can do a basic break-even analysis. Simply divide the cost of the mortgage points by the amount the reduced rate saves you each month. To see how this works, go back to the example figures above: we were looking at a $200,000 mortgage and the opportunity to reduce the interest rate from 5.500% to 5.250%, with one point costing $2,000.
- If you don’t buy any points, you’d pay $1,136 a month, and the total mortgage cost over 30 years would be $408,960.
- If you buy one point, you’d pay $1,104 a month, and the total cost would be $397,440.
- The monthly difference is $32, so it would take about 63 months (a little over 5 years) until you made back the initial $2,000 (2,000 ÷ 32 = 74).
- If you were to stay in your home for the whole loan term of 30 years, your savings would be $11,520 (or $9,520 factoring in the initial $2,000 fee).
Note that this example just looks at your mortgage cost – not your total housing costs – and it doesn’t take down payments into account. If you applied the $2,000 to your down payment rather than pocketing it, it could have a different impact on your savings, depending on PMI rates and other factors. Your lender can help you run your exact numbers.
Are Mortgage Points Negotiable?
You can decide whether to buy points, and how many, but you generally won’t be able to negotiate the per-point rate reduction.
Be aware that lenders may make their rates look lower by adding mortgage points to their loan offers regardless of whether you asked to buy them. Your best bet is to specify zero points when asking for loan offers. That way you can compare apples to apples – one lender to another using similar criteria. Once you choose your mortgage lender, you can decide to buy mortgage points and lower the rate.
Do You Have to Pay for Points With Cash?
No you do not have to pay cash for points you purchase. You can finance points your purchase into your mortgage. Your mortgage lender will be able to help you determine the pros and cons of financing your points.
What About “Negative Points”?
This term can be confusing to homebuyers, but basically, negative discount points are just discount points in reverse – cash rebates from lenders that lower closing costs and raise interest rates.
These aren’t as common, because most homebuyers want to keep their interest rate as low as possible, but they can be used when homebuyers have very little liquid cash or need to save as much of it as possible for renovations or other imminent expenses.
The Final Word
Every homebuyer is faced with a variety of important decisions – like whether to buy mortgage points – and sometimes the process can feel overwhelming.
No matter whether it’s your first house or your fifth, you’ll be empowered to make smart decisions when you work with the right financial partner. All of the ENB Mortgage Experts will explain all your options in detail, answer all your questions, and help you make the choice that’s right for you. Visit our company directory to learn more about our team.