Mortgage Points Explained

When securing a mortgage, it's important to grasp all the elements that affect your interest rate and overall loan costs. One often overlooked but valuable option for homebuyers is mortgage points. These points can reduce the total cost of your mortgage and potentially save you thousands over the life of your loan. Here’s a breakdown of what mortgage points are and how they can benefit you.

What Are Mortgage Points?

Mortgage points, also known as discount points, are upfront fees you pay to your lender at closing to lower your mortgage interest rate. In simple terms, you're paying part of the interest in advance to lock in a lower rate. Each point typically costs 1% of your total loan amount. For instance, on a $300,000 mortgage, one point would cost $3,000.

Types of Mortgage Points

• Discount Points:
  These points are purchased to reduce your mortgage interest rate. Typically, each point lowers your rate by about 0.25%, although this varies by lender. The more points you buy, the lower your rate—and the greater your savings over time.

• Origination Points:
  These are fees that cover the cost of processing the loan, but they don’t affect your interest rate. Unlike discount points, origination points are often negotiable.

How Mortgage Points Save You Money

• Lower Monthly Payments:
  By buying discount points, you reduce your interest rate, which decreases your monthly mortgage payment. Over a 30-year loan, even a small interest rate drop can add up to thousands in savings.

• Long-Term Savings:
  The longer you stay in your home, the more mortgage points can save you. For example, reducing your monthly payment by $100 and staying for 10 years translates to $12,000 in savings.

When Should You Consider Buying Mortgage Points?

• Long-Term Homeownership:
  If you plan to stay in your home for many years, the upfront cost of points can pay off in long-term savings through lower interest rates.

• Current Market Rates:
  When interest rates are high, buying points can make your mortgage more affordable. However, when rates are already low, the benefit might not outweigh the upfront expense.

• Available Cash at Closing:
  If you have extra cash on hand, buying points can be a good strategy to save in the long run, as long as it doesn’t strain your savings or emergency funds.

Calculating the Break-Even Point

The break-even point is when the savings from lower monthly payments equals the upfront cost of the mortgage points. To find it, divide the cost of the points by the monthly savings. If you reach the break-even point in five years but plan to stay for 10, buying points makes financial sense.

Tax Benefits

Mortgage points are often tax-deductible as mortgage interest, though the rules can be complex. Points paid for a primary home are usually deductible in the year they’re paid, while points on a refinancing must often be deducted over the loan’s term. Always check with a tax professional to understand your specific situation.

Bottom Line

Understanding mortgage points can lead to significant savings if you’re planning to stay in your home long-term. By lowering your interest rate and monthly payments, you could save thousands over the course of your loan. Consider your financial position, future plans, and the current rate environment to determine if buying points is the right strategy for you. With some upfront investment, the long-term rewards could be substantial.