If you’re new to the homebuying process, you may have heard the term “mortgage points” and wonder what it means. We’re here to help explain it all to you.
What are mortgage points?
In a nutshell, mortgage points are additional closing costs you pay in order to save money down the line. It works because your overall interest rate will be reduced for each point you buy at closing. Essentially, you’re prepaying the interest on your mortgage with the idea that it will save you money in the long term. Think of it as an investment. The money you spend now will reduce the amount you pay over the life of your loan.
Each point typically costs you 1% of your total loan amount. For instance, let’s say you find a home for $250,000 and are prepared to pay a 20% down payment ($50,000) on that home. After your down payment and closing costs, you’re only looking to borrow $200,000. In this scenario, one mortgage point would cost you $2,000, which is 1% of the total amount of your loan.
You may wonder how much of an interest rate deduction each mortgage point is going to get you. The answer varies by lender, which is why it’s important to do your homework before choosing your home mortgage lender. A typical interest rate deduction is a quarter of a percentage point for each mortgage point paid.
Continuing with the scenario from above, if you’re approved for a home mortgage at an interest rate of 4.00% and purchase one mortgage point for $2,000, your reduced interest rate will be 3.75%. Read on to determine how much this could save you and whether it’s worth buying points.
What do you need to know?
One of the most important things is to determine your breakeven point, or how much time has to go by before you save the amount of additional money you spent in closing costs by purchasing the mortgage points.
Sticking with our example, you decide to buy one mortgage point for $2,000, lowering your 4.00% interest rate by a quarter percentage point to 3.75%. At a 4.00% interest rate on a 15-year home mortgage for $200,000, your monthly payments would be around $1,479. But if you lower your interest rate by purchasing one mortgage point, your new monthly payment is around $1,454, saving you $25 a month.
So how much time needs to pass for you to earn back the money spent on that initial mortgage point? With our example, you’d save $300 a year with a lower interest rate. So it would be just over six and a half years, or 80 months until you reach your breakeven point.
Should you buy mortgage points?
This depends on a number of factors. Consider how long you intend to stay in the home. If you want to start a family, and plan on upgrading to a larger home in a few years, then mortgage points probably aren’t your best option. But if you’ve found your dream home and know that you want to settle there permanently, mortgage points could be a great way to lower your interest rate and save money over time.
It’s important to do your homework, crunch the numbers, and comparison shop between lenders. Remember that interest rate deductions for each point purchased will vary by lender.
Also, in our example, we used a 15-year mortgage term. But you may opt for a 30-year mortgage instead. Or you may decide you want to purchase two or three mortgage points instead of just one. Whatever you decide, grab your handy calculator and run the numbers. This will help you find your breakeven point so you can decide whether purchasing mortgage points would be worth it for you.
Consider Other Options
Consider alternatives for lowering your interest rate. If you don’t have the best credit right now, but are on your way toward improving it, refinancing your mortgage might be an option. When you refinance your mortgage, you pay off the existing home loan and start over with a new one, typically at a lower interest rate.
Another option is to save the money that you’d spend on mortgage points and use it to make a larger down payment on your home, reducing the total amount of your borrowed loan.
Questions
We’ve given you a lot to think about. Can’t decide, or still have questions? Make an appointment at any of our convenient branch locations and talk with one of our mortgage lending pros. And if you’d rather get started on your own, visit our online Mortgage Center or crunch the numbers yourself with our handy financial calculators.
