If you are in the market for a new home, or a refinance, you will eventually be asked by your lender if you wish to purchase mortgage points, or discount points. In this article, we will take an in-depth look at mortgage points. First, what are they? How do they benefit the homeowner? When does it make sense to purchase them and how many points should I purchase? Let’s jump in!
What are mortgage points?
Mortgage points, or discount points, is a transaction with the bank during the home buying or refinance process by which the buyer agrees to pay a lump sum up front in exchange for locking in a lower interest rate for the duration of the loan. It will lower your monthly mortgage payment and it will also result in less interest paid to the bank over time.
“Sign me up!” You might be saying to yourself. Hang on, not so fast. While this might sound like a no-brainer, it actually benefits far less homeowners than you might think.
Insurance points typically cost 1% of the loan amount. This means if you are financing $200,000, each mortgage point costs $2,000. How much will buying a point lower your interest rate? Well, each bank or lender defines what a “point” means for them. However it is typical to see 1 point equal between 1/8th to 1/4th of 1 percent off your mortgage rate. So, for every $2,000 you fork over at closing to purchase a mortgage point, you are lowering your mortgage rate anywhere from .125% to .25%.
Should I purchase mortgage points?
To discover the answer to the question for you and your family, it is important to consider your long-term plans for this home, and to look at some statistics regarding unforeseen events.
As we mentioned, at closing you are giving the bank cash for a reduced interest rate, thus a lower mortgage payment. The calculation therefore is quite simple to realize your breakeven point. If a point costs you $2,000, and saves you $20 a month on your mortgage payment, 100 months need to pass before you break even, or 8 years and 4 months. The question is, do you plan on staying in this home more than 8 years 4 months? And if so, is it significantly longer? Because there is also a concept call the time value of money to consider. This is a fancy way of saying, that $2,000 is worth more to you now than it will be later. You could invest that $2,000. You could use it to take a trip, finance your child’s education, make a purchase that will upgrade your life.
We are talking in hypotheticals to introduce you to the concept and get you thinking about the benefits and drawbacks of purchasing mortgage points. The reality is, purchasing mortgage points may or may not be extremely beneficial for you. The best way to find out is to plug in the numbers. There are many calculators online that can help you realize what you could save by purchasing mortgage points and what your breakeven point will be. Use this information and consider your plan for staying in the home, while also considering potential unforeseen circumstances.
The average person stays in their home between 6-10 years. If you plan to be there much longer, it may make sense to pay mortgage points and lower the interest rate up front. For the majority of us, they simply don’t make sense, the math doesn’t work in our favor.
Hope that helps! As you consider your options, please don’t hesitate to give us a call, we are happy to help!