Buying a home is the most expensive purchase most of us will make in our lives, so of course anything that can reduce your mortgage costs is worth looking into. In addition to negotiating a good price and finding the best mortgage rate, some homebuyers also purchase mortgage credits.
So what are mortgage points? Also known as “rebate points,” they’re basically a way to lower your interest rate — for a fee.
Let’s take a closer look at mortgage points, how they work, and when to use them.
What are Mortgage Points?
A mortgage point is a fee a borrower pays to a mortgage lender to lower the interest rate on their loan, thereby reducing the total amount of interest they pay over the life of the mortgage. This practice is sometimes called “discounting.”
The fee is 1% of the mortgage amount for each item purchased by the borrower. So one point on a $300,000 mortgage will cost $3,000.
In fact, mortgage credits are a form of prepaid interest. By purchasing these points, you can reduce the interest rate on your loan, usually by 0.25% per point. You can usually buy zero points or up to three full points – sometimes even more.
By lowering the interest rate on your loan, you can lower your monthly payments. Note, however, that this requires prepayment. Generally, the longer you intend to live in your home, the more you will earn by paying for points. Use this calculator to find out how much your mortgage interest points could save you.
How do mortgage points work?
A mortgage point typically costs 1% of your loan amount and reduces your interest rate by about 0.25%. For example, if you applied for a $200,000 loan, one mortgage point would cost you $2,000 and give you a 0.25% discount on your interest rate, while two mortgage points would cost you $4,000 and reduce your interest rate by 0.5%.
The cost per mortgage is entirely dependent on your loan amount – in other words, the larger your home loan, the more you will have to pay per mortgage. For budgetary reasons, keep this in mind when figuring out how much you’ll need to pay upfront to buy a home.
How Much Money Can You Save With Mortgage Points?
The amount you save over the life of the loan depends on the amount of your loan, the number of mortgage points you buy up front, the size of your rate cut, and the length of your loan.
Bank of America exemplifies savings with a $200,000 loan at a 30-year interest rate of 4.5% – in this case, without purchasing any mortgage points, leaving the person with $1,013.37 per month in interest and principal payments. However, according to the example, if a home buyer purchased a $2,000 mortgage point, they would drop the rate to 4.25%, and instead of paying $1,013.37 a month, they would only pay $983.88 a month. This equates to a total interest savings of $10,616.40 over a 30-year period. If you include the mortgage point cost of $2,000, you end up with a net savings of $8,616.40.
If a homebuyer buys two mortgages instead of one, the savings are essentially doubled over the 30-year period — a $4,000 downpayment for two mortgages would bring the rate down to 4%, with monthly payments $983.88 can be raised by $954.83. Over 30 years, this home buyer would end up saving $21,074.40. If you include the $4,000 cost of both mortgage points, you end up with a net savings of $17,074.40 over 30 years. In this example, it would take 68 months to break even to cover the $4,000 cost of purchasing mortgage points.
Of course, once you know how much loan you need and what your interest rate is, you’ll need to create your own numbers – your lender can help you with these calculations so you can better predict what your savings might be look like. Also, putting more money down on a house may make more sense than buying mortgage points.
Should You Buy Points For Mortgage?
Buying mortgage credits is a way to pay upfront to lower the overall cost of the loan and reduce your monthly payments.
In some cases it makes the most sense:
- If you plan to stay at home for a long time. Because buying points on a mortgage lowers the interest rate over the life of the loan, every dollar you spend on points will cost you more the longer it takes you to pay off your mortgage. So if you plan to spend some time indoors, the amount you save each month may make the upfront cost worth it. (Conversely, if you don’t intend to live in a house long-term, you may lose money overall by paying points.)
- They’ve dropped 20%. If so, avoid buying private mortgage insurance (PMI) and possibly get the best rate your lender can offer you. But if you haven’t hit the 20% mark on your down payment, putting your money there instead of points will likely still lower your rate, and possibly by more. That’s because a higher down payment reduces your loan-to-value ratio (LTV), which is the ratio of the amount of your mortgage to the value of your home.
- They don’t plan to refinance anytime soon. Even if you plan to stay indoors for a while, the current relatively high interest rate environment may prompt you to consider reinvesting later. Refinancing changes your mortgage rate.
So if you think you might be in this situation in the future, it might be wise not to buy mortgage credits now.
Ultimately, borrowers should consider all factors that may determine how long they want to stay in the home under their mortgage – such as the size and location of the property, their employment situation, and the current mortgage rate environment – and then calculate how much Long before they can buy mortgage credits, they need to get around breaking even.
