Are Mortgage Points a Good Idea?
When it comes to deciding on what type of loan you will need to purchase a house, it’s a good idea to arm yourself with as much information as possible.
One topic that comes up time and again is buying mortgage points and whether they can save you in the long run, if the numbers line up correctly.
If you don’t know what they are, just read on.
What are mortgage points?
In a nutshell, mortgage points are discounted interest payments to your lender when closing on your home. Also called “discount points” or the “buying down rate,” one mortgage point is worth 1% of your loan’s amount. In dollars and cents, that would equate to paying $1,000 for every $100,000 of the loan.
Your lender typically offers them to you alongside your mortgage quote. If you take advantage of the mortgage points offer, you are paying interest on your loan upfront in order to reduce the rate over its lifetime. When you receive your mortgage quote, your lender will include your loan rate and detail your mortgage points.
Here’s a tip: When you’re loan shopping, ask each lender for two estimates: one for your mortgage closing costs if you buy points, another for the loan without points. Show the estimates to a tax preparer.
Should you take advantage of this offering?
Buying points could be helpful if:
You’re purchasing your forever home.
You have enough cash upfront to make a large down payment and still have some left for lowering the rate.
You expect to keep the loan long enough that you’ll exceed the break-even point in this calculator.
But buying points can be a bad thing if:
You’ll sell the home or refinance before you’ve hit your break-even point.
You need the cash you’ll use to buy points.
You reach the break-even point, but the monthly savings are so small that it doesn’t make a meaningful dent in your budget.
While you’re doing this initial assessment, it’s also key to look honestly at your access to cash and ask yourself: “is there enough to pay for the points, my down payment, closing costs, and reserves?”
If the answer is yes, the benefits of buying mortgage points might be just what you need.
Two types of mortgage points
Discount points
Discount points are prepaid interest on your mortgage loan.
As the homebuyer, you’re offered the opportunity to purchase anywhere from zero to four points depending on how much you want to lower your rate.
For example, for a $300,000 loan, one mortgage point is worth $3,000. After calculating, one mortgage point at a 4% interest rate for a 30-year mortgage brought the savings to over $10,000 for a 10-year period, while four mortgage points saved less than $2,500.
Origination points
Origination points are charged by the lender and cover the cost of making your loan. Origination points can be tax deductible, but with a few caveats: they’re deductible when you use them to obtain your mortgage, but not to pay other associated closing costs. The IRS details what can and cannot be deducted, including notary and inspection fees.
How to calculate when you’ll break even with mortgage points
In addition to the length of time you plan on staying in the home, another number to crunch before deciding on whether or not you will buy mortgage points is the “break even period.” This is the length of time it will take for you to recoup the money you paid out for the points.
To calculate this, divide the cost of the points by the savings on your monthly payment. The resulting number is the length of time it will take for your monthly payment savings to equal what you paid for the points. In the case of the $300,000 home, savings with one mortgage point are about $73 per month, dividing that by $3,000, we get a total of 41 months, or roughly 3.4 years to “break even.”
It’s also important to note that the rate isn’t set and relies on your lender and the marketplace. Similarly, if you’re buying mortgage points for an adjustable rate mortgage (ARM), the deduction is different and often only provides you a discount for a shorter, set amount of time, such as the initial fixed-rate period.
What do points cost?
One mortgage point typically costs 1% of your loan total. So, if you buy two points — at $4,000 — you’ll need to write a check for $4,000 when your mortgage closes. That check is in addition to paying closing costs (which run from 3% to 6% of the mortgage total, or about $6,000 to $12,000 on a $200,000 home).
You can buy points either when buying a home or refinancing your home loan. It’s sometimes called “buying down” your rate. Lowering your interest rate reduces the size of your monthly payments.
Another kind of points are “negative points” or “rebate points.” In this scenario, the closing costs on your mortgage are added to the cost of your loan in the form of a higher interest rate. You may have heard of a no-closing costs mortgage. This is it — you don’t need cash for closing.
But the higher rate means a higher monthly payment. The trade-off can be useful if you don’t have cash for closing costs.
Are mortgage points tax-deductible?
While mortgage interest is still tax deductible, the Tax Cuts and Jobs Act of 2017 puts a cap on the amount of mortgage interest that may be deducted. Because discount points are prepaid interest, they may be deducted as part of your home mortgage interest.
Note: Lenders are required to provide a closing disclosure form that shows all the fees you’ll pay three business days before the scheduled closing of your loan.
