Overview
Buying a home is a significant milestone, but navigating the world of mortgages can be complex. Among the various terms, “mortgage points” frequently arise. Understanding mortgage points can save you thousands of dollars over the life of your loan.
What Are Mortgage Points?
Mortgage points, also known as discount points, are a form of pre-paid interest on a mortgage loan. Each point equals 1% of the total loan amount. By purchasing points upfront, borrowers can lower their interest rates and reduce monthly mortgage payments.
Calculating the Savings
To determine if buying points is worthwhile, you need to calculate the “break-even point”—when the upfront cost of points is recouped through lower monthly payments.
Example Calculation:
- Loan Amount: $200,000
- Interest Rate without Points: 4%
- Monthly Payment without Points: $955
- Cost of One Point: $2,000 (1% of loan amount)
- Reduced Interest Rate with One Point: 3.75%
- Monthly Payment with One Point: $926
- Monthly Savings: $29
- Break-Even Point: $2,000 / $29 ≈ 69 months (~6 years)
If you plan to stay in your home beyond the break-even point, buying points could result in significant long-term savings.
Factors to Consider
1. Length of Stay:
- If you plan to stay in your home for many years, buying points can yield substantial savings.
- If you anticipate moving within a few years, the upfront cost of points might outweigh the benefits.
2. Available Funds:
- Purchasing points requires upfront cash. Ensure you have sufficient funds without compromising your emergency savings or other financial goals.
3. Interest Rates:
- Monitor current interest rates and compare the potential savings of buying points versus accepting the standard rate offered by your lender.
4. Tax Implications:
- In some cases, mortgage points may be tax-deductible. Consult with a tax advisor to understand how buying points could affect your tax situation.
Types of Mortgage Points
1. Discount Points:
- Directly impact your interest rate. Each discount point typically lowers your interest rate by 0.25%.
2. Origination Points:
- Charged by the lender to cover the cost of originating the loan. Unlike discount points, origination points do not lower your interest rate but compensate the lender.
Conclusion
While mortgage points can potentially save you thousands of dollars over the life of your loan, they are not the right choice for everyone. Consider your financial situation, long-term plans, and current market conditions before deciding whether to buy points. By understanding mortgage points, you can make informed decisions and achieve greater financial stability in the long run.
