What Are Mortgage Points And When Are They Worth It?
At first glance, the idea of paying more in closing costs might seem ridiculous, but there are some cases where buying mortgage points can save you a substantial amount of money over the life of your new mortgage.
Let’s break down what mortgage points are and how they work to find out if they’re right for you.
How Mortgage Points Work
Mortgage discount points are all about playing the long game. The longer you plan to own your home, the more points can help you save on interest over the life of the loan.
Understanding The Break-Even Period
When shopping for mortgages and considering points, it’s important to calculate how long it would take to recoup the upfront costs of purchasing points. This is commonly referred to as the break-even period.
To calculate the breakeven period, divide the cost of the points by how much you’ll save on your monthly payment. This will give you the number of months it will take for the monthly payment savings to equal the upfront costs of buying points.
Mortgage Points Example
Let’s use a $150,000 loan as an example to illustrate how discount points work. You can use an amortization calculator to do your own comparisons based on different loan amounts and interest rates.
Hypothetical loan amount: $150,000 for 30 years
|Points||Cost at Closing||Interest Rate||Monthly Payment||Monthly Payment Savings||Break-Even Period||Payment Savings on 30-year Loan|
|$1,875||4.75%||$782.47||$21.85||7 years, 2 months||$7,866|
|2||$3,000||4.25%||$737.91||$66.41||3 years, 10 months||$23,907.60|
As you can see from the chart above, even though 1.75 points costs $2,625 up front, you will end up saving $15,944.40 over 30 years because of the lower interest rate. And even if you don’t stay in your home for 30 years, you’ll break-even in about 5 years.
In this example, if you’re planning on living in your home for more than the breakeven period, mortgage discount points could be a money-saving option.
It’s important to note that the numbers in the above example are hypothetical. The rate given for a certain number of purchased mortgage points varies by lender. Additionally, these calculations don’t include property taxes and insurance.
Mortgage Points On An ARM
It’s possible to buy mortgage points on an adjustable rate mortgage, or ARM. However, any discount points you pay generally only apply to the initial fixed rate you get, often called the initial rate or "teaser rate".
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How Many Mortgage Points Can You Buy?
There’s no one set limit on how many mortgage points you can buy. However, you’ll rarely find a lender who will let you buy more than around 4 mortgage points.
The reason for this is that there are both federal and state limits regarding how much anyone can pay in closing cost on a mortgage. Because limits can change from state to state, the number of points you can buy may vary slightly.
It’s important to note you don’t have to pay for a full point to get a lower rate. Points are sold in increments all the way down to 0.125%.
Are Mortgage Points Tax Deductible?
Points are considered prepaid interest, so they may be deductible as home mortgage interest. At present, it’s possible to deduct the interest on up to $750,000 worth of mortgage debt if you’re a joint filer or $375,000 if single or married and filing separately.
To get a tax benefit, you’ll need to fill out Form 1040, Schedule A and itemize these deductions.
When Are Mortgage Points Worth It?
While mortgage discount points are an excellent choice for some borrowers, they’re not right for everyone. To determine if mortgage points are right for you, there are two main questions to ask yourself.
How Long Do You Plan to Live in Your Home?
As mentioned in the example above, the length of time you stay in your home is one of the most important factors. If you’re a wandering soul and you only plan to live in your house for a few years, it’s probably a better decision to pay lower closing costs and higher monthly payments.
How Much Money Do You Have to Put Down at Closing?
If your down payment on a conventional loan is under 20%, you may be required to pay private mortgage insurance (PMI), which typically costs 0.1 - 2% of the loan amount annually. In the case of a conventional loan for $150,000, 1% PMI will cost $1,500 a year or $125 a month.
This is important for clients who are on the fence between paying for mortgage discount points or a larger down payment. If it’s between discount points and boosting your down payment to 20% or over, you’ll want to choose the down payment most of the time. Always do the math and consider if your discount points are costing you more or less than your monthly PMI fees.
PMI rates do vary from lender to lender, so this is a question worth asking if you’re shopping for a conventional loan. It’s also important to know that mortgage insurance guidelines will depend on the type of loan you have (conventional, FHA, VA, etc.).
Are Mortgage Points Right For You?
There are a variety of factors that go into whether you should purchase discount points to buy down your interest rate.
The good news is you don’t have to crunch the numbers yourself. For help determining if mortgage points might be right for you, contact a Home Loan Expert.