If you’re in the process of purchasing or refinancing a home, chances are you’ve come across the term mortgage points. Essentially, mortgage points (sometimes called discount points) are upfront fees paid to the lender in order to receive a lower interest rate. Although mortgage points can potentially save you thousands of dollars over the duration of your loan, in many cases, it isn’t worth the upfront costs.
How do Mortgage Points Work?
Generally, the more time you plan on staying in your home, the more beneficial mortgage points become. One mortgage point equals 1% of your mortgage. For example, if you have a $100,000 loan one point would equal $1,000. But if you have a $200,000 loan, one point would equal $2,000. Don’t forget, borrowers can purchase more than a single point or even fractions of a single point.
In exchange for these additional payments upfront, the lender will offer the borrower a reduced interest rate. This is often referred to as “buying down” your interest rate. The rate of reduction varies by lender. One lender may reduce your rate by a half percent for a single mortgage point while other lenders may require 1.5 points for the same reduction rate.
When Should I Pay Mortgage Points?
Paying mortgage points might be the right option for you if:
- You’ve already put down 20% and have additional cash to spare.
- You’re taking out a fixed-rate mortgage, as opposed to an adjustable rate mortgage
- Interest rates have been rising or are particularly high
- You’re planning to stay in the home long enough to reap the benefits
Considering the length of time it will take for you to break even is an important factor when deciding whether to pay mortgage points or not. The find out how long it will take for you to break even, divide the total costs of the points you’re paying by how much money you’ll save each month. The quotient will by the number of months it will take to recoup the costs of buying down your rate. Let’s say your loan amount is $400,000 and you plan to pay one point equal to $4,000. This point will save you $60 a month on your mortgage. It will take you about 66 months to break even.
When Should I Not Pay Mortgage Points?
Generally, you should not pay mortgage points if:
- You have not made a down payment of at least 20%. Putting down 20% will prevent you from needing to purchase private mortgage insurance, which will most likely negate any interest savings from buying mortgage points.
- You are not planning to stay in the house long enough to break even.
- You are applying for an adjustable rate mortgage rather than a fixed rate.
- Interest rates are already historically low.