When Should I Buy Mortgage Points?
When you’re ready to buy a home, you can lower your interest rate by buying mortgage points. If getting the lowest interest rate is your primary goal, then choosing to buy mortgage points or “discount” points can make a lot of sense. But paying mortgage points at closing isn’t always the best financial decision when it comes to saving money on your mortgage. It all depends on your financial goals.
I’ve had a handful of clients who want to do everything they can to bring down their interest rate. But after discussing the terms of the loan, closing costs, and how much money they want to put down, they often change their mind.
If you’re trying to decide whether or not paying mortgage points is a smart move, this article can help.
Mortgage Basics: What Are Mortgage Points?
There are two types of mortgage points: Discount points and rebate points. When people talk about paying mortgage points or buying mortgage points, they are typically referring to discount points. Mortgage points, or discount points, allow you to reduce your interest rate by paying your mortgage interest upfront.
Mortgage points typically cost 1% of your total loan amount. For example, for a $400,000 mortgage, 1 point would cost $4,000 (2 points would cost $8,000, etc.) In exchange, you’ll typically receive a reduced interest rate of 0.25% for each point.
Real-World Example: How mortgage points can reduce your interest rate and mortgage costs
Sample loan for a fixed-rate 30-year home loan for $450,000:
- Loan amount: $450,000
- Loan term: 30-year fixed rate
- Interest rate: 4.25%
- Monthly payment: $2,214
Sample scenario if you decide to pay 2 mortgage points:
- Loan amount: $450,000
- Loan term: 30-year fixed rate
- Mortgage points: 2
- Reduced interest rate: 3.75%
- Lower monthly payment: $2,084
- Monthly savings: $130/mo
- Break-even period: 69 months
- Cost: $9,000
In short, this means that paying 2 mortgage points (0.25% discount per point) would cost $9,000 (2% of the loan amount). Paying 2 mortgage points would reduce your mortgage payment by $130/mo and take 69 months to “break even” or recover that cost. On month 70, you’d start the real benefits of a lower monthly payment.
The example above offers a framework to evaluate if paying points is the best decision.
A few questions to consider:
Do you plan on staying in your home for at least 8 years (or the equivalent break-even period)?
If this is going to be your forever home, it might benefit you to pay points for a reduced interest rate. But if you plan to move or refinance in less than 10 years, paying points might not be beneficial.
Do you have enough cash to make a substantial down payment and also pay points?
If not, it might be better to focus on your down payment. By making a larger down payment, you’ll have a smaller loan amount and a lower mortgage payment.
Is there a better way to invest your money instead of buying points?
In the example above, you’d pay $9,000 in points when your loan closes. Consider whether or not there may be an alternative for your $9,000 which could yield better returns.
Check out a mortgage calculator to see what you can afford and if paying points will help meet your homeownership goals.
Is it worth it to pay points on a mortgage?
Yes and no. In the example above, you can see how paying mortgage points upfront can save you money on your mortgage over the long term. But if you end up selling your house or refinancing in the short-term, paying mortgage points could end up costing money upfront at closing that you won’t recover.
Similarly, if you need the additional cash for emergency funds, home repairs, or other needs, it’s probably not wise to become cash-poor just to save 0.25% on your mortgage interest rate.
Today, with mortgage rates still at historic lows, it’s difficult to justify paying down your interest rate in most circumstances. That said, if you have the cash and you plan on staying in your home for more than 8 years, you can definitely save money on interest over the life of your home mortgage.
Is it smarter to buy mortgage points or make a bigger down payment?
Let’s say you have $9,000 in additional funds that you want to put toward your new home loan, and you’re not sure if you should buy mortgage points or put it toward your down payment.
Going back to the example above, you could put the $9,000 toward your down payment, reducing your home loan to $441,000. While this might not seem like a substantial difference, it would lower your monthly payment to $2,169.
What’s more, by increasing your down payment, you can improve your loan-to-value (LTV) ratio. A better LTV can translate into a lower interest rate or better terms. If your down payment crosses the 20% threshold, you’ll save even more.
The truth is, talking with an experienced mortgage broker can help. Several factors affect every mortgage application, such as your credit score, debt-to-income ratio, and income verification. Custom loan options can create the best terms for your financial situation. Together, these factors impact the overall terms of your loan offer. Paying mortgage points is one element in a much bigger picture.
Are mortgage points tax deductible?
Yes, mortgage points are tax-deductible in most circumstances. Mortgage discount points are prepaid interest on your mortgage and are treated the same as mortgage interest on your tax return. Note that the Tax Cuts and Jobs Act of 2017 puts a limit on the amount of mortgage interest you can deduct, so it’s best to check with your tax accountant for current limits and tax laws.
Paying mortgage points is a clear path to getting a lower interest rate and saving money if you plan to stay in your home long-term. That said, paying discount points in addition to a down payment and other closing costs can be financially demanding. Before you deplete your savings, talk with your mortgage broker to find out how much you’ll save each month and how long it will take before you break even. Finally, if you have the extra cash, consider making a larger down payment which might generate better loan terms and save you more money than buying mortgage points.
Working with an experienced mortgage broker makes all the difference when it comes to saving money on your mortgage. If you’d like to discuss whether or not paying mortgage points is a smart move, give us a call. We can help discuss your options and customize a mortgage that meets your homeownership goals.