If you are in the process of taking out a mortgage and are currently comparing the rates and terms of different lenders, it may also be worth considering how much are lenders selling mortgage points for. Mortgage points help you lower your mortgage rate against a cost that is typically 1% of the amount borrowed.
What are mortgage points?
Mortgage points can be purchased by borrowers who want to reduce their mortgage rates. These are also called discount points. One discount point will lower the mortgage rate by 0.25% and it typically costs 1% of the total loan amount. For example, if you take out a mortgage of $200,000 at a mortgage rate of 3.5%, one mortgage point will cost you $2,000 and will reduce your mortgage rate to 3.25%. Borrowers can compare between lenders and negotiate with them in order to get the best deal.
Another type of mortgage points are negative points. Negative points are typically used when you do not have enough funds to pay your closing costs. In this case scenario, the lender rolls the closing costs into the loan balance in return for a higher mortgage rate, which then translates into a higher monthly mortgage payment.
Break-even period
The purpose of a mortgage point is that it allows you to save interest throughout the years by lowering your mortgage rate. A lower mortgage rate means that you will make a lower mortgage payment monthly. However, a borrower will not really be saving anything until they have fully made back what the mortgage point cost them in the first place. Continuing the previous example, you will have to first break even on the $2,000 that you initially spent to purchase the point. This period of time where the interest “saved” makes up for the cost of purchase, is called the break-even period. Only after the break-even period has passed can a borrower truly take advantage of the mortgage point that they initially bought. You can calculate the break-even period and interest savings from your mortgage points by using a mortgage points calculator.
Is it worth it to purchase mortgage points?
The answer to this question largely depends on how long you plan to stay in your home before moving out or how long before you refinance your mortgage. The longer these time periods, the more you will end up saving in interest by purchasing mortgage points.
There are a number of scenarios when purchasing mortgage points makes the most sense:
1- When you plan to stay in the home forever – If the home that you are purchasing is your forever home, then purchasing mortgage points will save you money from the time that the break-even period ends until the whole loan is paid off. You will be saving the money you would have otherwise spent on the larger mortgage payment. This is only if you don’t refinance the mortgage during this time.
2- You have enough funds – If you have enough cash to put a large amount down upfront and you can still afford to purchase mortgage points, then buying points to lower the mortgage rate can prove to be worth it.
3 – You plan to keep the loan longer than your break-even period – As mentioned previously, you will only save money once the break-even period of your mortgage points has passed, since up to that point, you will only be making what you spent to purchase the mortgage points. For example, if the break-even point of your mortgage points is 70 months, you should only purchase mortgage points, if you plan to keep the loan longer than 70 months.
In other cases, purchasing mortgage points may end up costing you more than what you will end up saving. Some of these scenarios include the cases when:
1 – You sell the home or refinance before the break-even period has passed – If you end up selling or refinancing before the break-even point, then the cost of the mortgage point will be greater than what you will end up saving in lower mortgage payments up to the point you sell the home or refinance the loan.
2 – You can’t afford it – You should first make the down payment and pay for closing costs, and after, you can consider purchasing mortgage points. If you have no leftover cash once you pay your other obligations, then you should not purchase the points.
3 – Monthly savings are insignificant – If the difference in the monthly mortgage payments will be so small that it wouldn’t make a difference to your budget, then investing in mortgage points may not be worth it.
In conclusion, mortgage points present a great savings opportunity for borrowers who have the available funds to purchase them. It is very important to note that purchasing mortgage points only makes sense if you do not plan to sell the house or refinance the mortgage before you hit the break-even point. Otherwise, you will end up spending more on the points, than the amount you will be saving through mortgage payments.
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