What are Mortgage Points?
Mortgage points, also known as discount points, are prepaid interest you pay to your lender at closing in exchange for a lower interest rate on your mortgage. Think of them as a way to buy down your interest rate. Each point typically costs 1% of your loan amount. For example, one point on a $300,000 loan would cost $3,000.
How Do Points Lower Your Interest Rate?
Lenders make money on the interest they earn over the life of your loan. By accepting points upfront, they’re essentially receiving a portion of their future interest earnings immediately. This allows them to offer you a lower interest rate on the remaining balance, making the loan more attractive to you.
Calculating Your Potential Savings
Determining whether buying points is a worthwhile investment requires careful calculation. You need to consider the upfront cost of the points against the potential savings in interest over the life of your loan. Online calculators and mortgage professionals can help you model different scenarios, showing how many points you’d need to buy to reach a specific interest rate, and what your total monthly payment would be. You’ll also want to factor in how long you plan to stay in the home. The longer you stay, the greater the chance you’ll recoup the cost of the points.
Breaking Even: The Crucial Factor
The key to making an informed decision lies in understanding your “break-even point.” This is the length of time it takes for the interest savings from the lower rate to offset the cost of the points you paid upfront. For example, if you pay $3,000 for points and save $50 per month in interest, your break-even point would be 5 years ($3,000 / $50/month = 60 months). If you plan to stay in your home for less than 5 years, you might not recoup your investment.
Considering Your Financial Situation
Before purchasing points, assess your financial situation. Do you have the extra cash available upfront? If you have to deplete your savings significantly or resort to a high-interest loan to cover the cost of the points, it may not be the best financial decision, even if the long-term savings are significant. The potential benefits need to outweigh the immediate financial strain.
When Buying Points Makes Sense
Buying points is often a savvy move for borrowers who plan to stay in their home for a long period—typically 7-10 years or more. It’s also a good strategy for those with excellent credit and a stable financial situation who can afford the upfront cost without compromising other financial goals. Borrowers with larger loans often find that the interest savings from purchasing points are more substantial, making the upfront cost more easily recouped.
When Buying Points Might Not Be Wise
If you anticipate selling your home within a few years, buying points may not be beneficial. The interest savings simply may not offset the initial cost before you sell. Similarly, if you’re on a tight budget or have less-than-perfect credit, the added upfront expense might put an unnecessary strain on your finances. It’s also worth considering if you’re comfortable with the slightly higher monthly payments you might have even if you buy down your rate, as the reduced rate may not significantly lower the monthly payments.
Working with Your Lender
Your mortgage lender is your best resource in making this decision. They can provide you with personalized calculations based on your specific loan amount, interest rate, and loan term. They can also discuss the various scenarios, including the impact of buying different numbers of points. Don’t hesitate to ask them questions and ensure you fully understand the implications of buying points before committing.
Beyond the Numbers: A Holistic View
While the numbers are important, don’t let them be the sole driver of your decision. Consider your overall financial well-being. Buying points should enhance, not jeopardize, your financial security. If the decision causes stress or uncertainty, it might be best to proceed cautiously or explore other options.