When Does It Make Sense to Buy Mortgage Points? 12 Things to Consider
Borrowing the hundreds of thousands of dollars typically required to buy a home isn’t always cheap, and the cost of a mortgage can make a huge difference in whether a home is affordable to a potential owner. One of the most common ways to reduce the monthly payment and make owning a home more manageable is by buying mortgage points. However, they’re not right for all potential buyers and situations. Here are 12 things to consider before deciding whether to buy them on your next loan.
What are Mortgage Points?
Mortgage points (also known as mortgage discount points) can help you lower the interest rate on your mortgage. They typically cost 1% of the total loan amount and reduce the loan’s interest rate by a quarter of a percentage point. For example, buying a point on a $400,000 mortgage will cost $4,000 and lower the rate from 7% to 6.75%. Many lenders cap the number of points you can buy, but the amount varies.
How Much of a Difference Does Buying Points Make?
Consider the $400,000 loan. At 7%, the monthly principal and interest on this loan is $2,661. At 6%, this drops to $2,398. That’s a difference of $263 a month and $3,156 a year, more than one full monthly payment. Homeowners can pocket these savings or, if their loan terms allow it, continue to pay the additional amount toward the mortgage principal. This will help pay off the loan years faster than otherwise, saving thousands in interest and helping buyers own their properties free and clear sooner.
12 Things to Consider About Buying Mortgage Points
Everyone wants a lower interest rate, but before you pull out that checkbook, keep these 12 things in mind.
1. How Long You’ll Be in Your Home
There’s a reason investors and flippers don’t buy points, and it has to do with the break-even period. The break-even period is the number of years you need to own your home to recoup your closing costs (including mortgage points). The more you pay at closing, the longer the break-even period is. If you plan to move within just a couple of years, paying mortgage points may not be a good idea as you won’t have enough time to truly benefit from them.
2. The Price of Points
We’ve mentioned the typical price and terms for points previously. However, some lenders may charge fees or add specific terms that increase the price or lower the interest rate. Read the terms and conditions carefully before committing.
3. Your Cash on Hand
First-time homebuyers may not realize just how much cash they’ll need for closing. There’s the down payment, any real estate agent commission they’re responsible for, and other fees charged by the lender and the agency that handles the closing. Between your realtor’s commission and other costs, the total amount due at closing can be higher than expected. If you don’t have much cash on hand for closing, you may want to hold off on buying points.
4. If the Monthly Payment Reduction is Worth it
It’s easy to see exactly how much buying mortgage points can reduce your monthly payment. Some people might not care about reducing their mortgage by a couple of hundred dollars a month, but others may find it eases the strain on their budget substantially. Before deciding whether or not to buy mortgage points, consider your lifestyle and financial situation to see if the monthly payment reduction over the life of the mortgage is worth the upfront cost.
5. The Term of Your Loan
Many home buyers don't realize how much interest they pay over the life of their loan. At a 7% interest rate, an owner paying the entire term of their 30-year mortgage on a $400,000 loan would pay over $558,000 in interest. Dropping that interest rate by one percent reduces that number by nearly $95,000.
The savings earned by buying points are most significant when you opt for a longer-term loan. You’ll pay less interest over the life of the loan, and a longer-term loan keeps your monthly payment manageable. Remember that even if you choose a 30-year mortgage, there are generally no penalties for paying it off early.
6. The Amount of the Loan
Because the cost of points is based on the loan amount, it makes sense that points for larger loan amounts are more expensive. Consider whether this cash outlay at closing is worth the long-term savings potential.
7. Current Interest Rates
When interest rates are low, purchasing mortgage points may not even be an option. Some banks cap the lowest interest rate they will charge, which means buying points isn't an option when overall interest rates are low.
Even if interest rates are low and your bank allows buying points, you may decide that spending extra cash upfront isn't worth the reduction in your monthly payment. First-time homeowners especially may want to keep their cash for unexpected expenses such as furnishing a larger space and minor upgrades or repairs to their new home.
8. Better Uses for Your Money
When it comes to saving money, buying mortgage points may not give you the best bang for your buck. Consider if there are better places to apply extra money, such as adding to your down payment, making investments, or eliminating higher-interest debt. The last strategy makes you a more attractive candidate for favorable loan terms and interest rates.
9. Tax Deductions
Many closing costs are not tax deductible, but some good news: mortgage points are generally tax deductible in the year you purchase your home. The major caveat is that the home needs to be a primary residence. Talk to your tax advisor or accountant to see if buying points is a beneficial tax strategy.
10. When You Refinance
Some home buyers purchase a house intending to refinance within a few years. This can be a good strategy if high interest rates are projected to drop, but it’s not a great idea when buying mortgage points. Refinancing before the break-even period means you lose the money you paid for points without realizing the full benefit.
11. Your Tolerance for Risk
Buying mortgage points are for people who know they plan to stay in their home for a long time and want a stable, predictable monthly payment. If you aren’t sure of your long-term plans, skip buying points. But keep in mind that unexpected changes leading to relocation can occur at any time.
12. Financial Incentives
There are many available financial incentives for buying a home. From rebates to favorable terms to grants for first-time buyers, mortgage points are just one way to reduce the cost of buying a home. Consider all of your options before spending precious cash on points.
Should you Buy Mortgage Points?
Ultimately, buying mortgage points depends on your investment goals and financial position. Each homebuyer comes to a purchase with different circumstances, so consider whether or not it makes sense to buy points before you head to closing.
