What Are Mortgage Points - And Should I Buy Them?
Buying a home is one of the largest financial transactions you’ll make in life. Any way you can lower your mortgage payment is worth looking at, including buying mortgage points to lower your interest rate. This could possibly save you thousands of dollars over the length of your home loan.
What are mortgage points?
Points on a mortgage are an industry term referring to the lump sum you pay at closing in exchange for a reduced interest rate over the life of the loan. These points are typically included in the closing costs, and they reduce your rate, thus lowering your mortgage payment.
Mortgage discount points are similar to getting prepaid interest for your home loan. Instead of paying for the interest over time, you incur an upfront cost to reduce the amount due. Because of this, the plan only makes sense if you plan to stay in the home over the long term. There are typically two types of mortgage points:
Discount points
These are typically the prepaid interest. Each point you purchase will lower your mortgage loan by a pre-agreed percentage, normally 0.25% - but this percentage can vary based on the borrower and the market conditions.Origination points
These are costs associated with mortgage processing. The lender can offer the points to shave off the principal amount. Origination points are less popular in today's real estate market as most lenders are offering no-fee or flat fee mortgages.If not, try to negotiate with your loan officer on the origination points.How do mortgage points work?
The "discount" points you purchase go into paying off some of your future mortgage payments upfront, reducing what would otherwise be your monthly payment. Generally, one mortgage point will lower the interest rates by a quarter of a percentage. This value can vary depending on the lender, loan type, loan term, and the number of points you want to buy. For instance, if you want to take out a $200,000 mortgage at a fixed rate of 4.5% with a repayment period of 30 years, each point would cost $2,000. It would cut 0.25% off the interest rate, lowering it to 4.25% and reduce your monthly payments from $1,013.37 to $983.88. Purchasing multiple points can lower your interest rates even more.How much do mortgage points cost?
The price of discount points may differ from one mortgage lender to the other. Contact your lender directly and ask about their current options for discounting the interest rate on your loan based on how much money is paid upfront at closing.How many mortgage points can I buy?
The number of discount points you can purchase when buying a home depends largely on the lender. Most lenders cap the number of points at 1% to 3% of the loan amount. They also allow fractional point calculation, such as half a discount point that reduces the interest rate by 0.125%. The choice of the number of mortgage points to lower your interest rate depends on your cash reserves, the type of loan you choose, and the lender's terms on the dropped percentage per discount point.Reasons to buy down the mortgage rate
Here are some reasons why you might want to buy mortgage points to lower your interest rate:- Less interest over the loan's life. Points are a percentage of the total loan amount, calculated as a one-time purchase rather than an ongoing payment. You can take advantage of the “prepaid interest” to make additional savings in your monthly payments.
- Lower monthly payments by reducing interest. Mortgage points are an investment that you make in your home purchase. You're essentially paying a fee to lower the interest rate on your loan and save money over the life of your mortgage.The amount you'll save depends on how many points you purchase, how long it takes to pay off those points, and what type of interest rate reduction they yield.
- You've got cash available to pay for points. Buying down the interest rate depends largely on the cash reserve you have to complete the transaction. You can use the additional funds from your savings for the down payment and closing costs to purchase mortgage points, consequently reducing the interest rates for the loan.You can use a mortgage calculator to find the exact costs of buying discount points.
- Get tax deduction benefits. The Tax Cuts and Jobs Act, which applies for the tax years 2018-2025, allows for the inclusion of mortgage points as tax-deductible on Schedule A, Form 1040. The IRS stipulates borrowers deduct the points proportionally over the life of the mortgage loan. The deductions are also limited to the first $750,000 of the loan. Speak to a tax accountant about the implications of the discount points on your taxes.
- Your credit score can't qualify for the lowest rate. If the available loan terms cannot lower your rate further, you can use mortgage discount points to reduce your monthly payments. The one-time lump sum amount guarantees a lower rate for your loan over the long term.
If you want to see if buying points to lower your interest rate is right for you, contact a loan officer to explore your options. We are happy to refer you to some of the lenders we frequently work with and trust!
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