Purchasing A Home: Should You Invest In Points?

The mortgage process can be stressful at times and baffling due to the heaps of paperwork and unfamiliar terminology. The process is further complicated by the fact that mortgage lenders and banks do things differently. Some lenders charge loan origination fees while others ask you to pay for mortgage points. Then again some lenders tag lender fees with points.

Let us understand what these terms mean.

The term mortgage points can refer to two completely different things: origination points and discount points.

Origination points are fees that you pay your loan originator and it does not affect your mortgage. Understanding these can help you comparison shop for the lowest fee and also negotiate the amount. Whereas, mortgage discount points have an impact on your interest rate. So, let us focus on how they work to find out if it is right for you.

To understand how mortgage points work you need to be acquainted with these two sets of numbers:

Mortgage points are calculated as a percentage of the total amount of your mortgage. Generally, one point will cost 1% of your total loan amount. So, if you are borrowing $200,000, you would pay $2,000 for one point.

The discount you receive per point varies by lender and loan program. However, for every point you buy, you can expect to reduce your interest rate by one-quarter of a percent. For example, your interest rate can be reduced from 4% to 3.75% when you purchase one mortgage point.

If you cannot afford to pay 1% of your mortgage, then the lender may allow you to purchase half-points too.

Generally, there is no rule as to the maximum number of points you can buy. However, most mortgage lenders limit the number of points to four. This is because there are both federal as well as state limits to the amount of money a person can pay in closing costs on a home loan.

By doing some math you can figure out the amount you save in interest rate and the break-even point (the amount of time it takes for you to recoup the savings you receive from a low interest)

For example, say you decide on a $300,000 mortgage with a 30-year term and 3.5% interest rate. If you purchase two points to decrease the interest rate to 3%, then you will pay $6000 as each point will cost $3,000. As a result, your monthly payment will decrease from $1,347 to $1,265, a savings of $82 per month. Divide 6,000 by 82 and you will find that it will take you approximately 73 months or 6.1 years to hit your break-even point.

Now let us see how much you would save on interest. If you did not buy any mortgage points then you would pay an interest of $184,968 over the life of the loan. But by spending $6,000 you will reduce your interest rate paid on the loan to $155,332. After deducting the $6,000 your savings will $23,636.

It is a great money-saving option if you plan to stay in your home for more than 6 years.

P.S: Mortgage points are offered both on fixed-rate as well as ARMs. However, on an ARM (adjustable-rate mortgage) the lower interest rate is offered for the fixed-rate period only.

The major advantage of purchasing mortgage points is securing a lower interest rate on your home loan. Reducing your interest rates is an important part of your mortgage for many reasons:

When you take out a mortgage you just do not pay the purchase price of the home and closing costs, you also pay interest. This adds up to a considerable amount as they last for many years. So, paying a lower rate means paying less interest over the life of the loan.

In general, lowering your interest rates means a decrease in your monthly payments. Paying for points is a one-time cost, but the benefit is that you get to pay a lower monthly payment for many years to come.

The cost you pay for points could be an itemizable tax deduction as it is considered to be “prepaying interest”. If you meet the IRS requirements you could take the entire benefits in the year you pay points, or you may be able to claim them over the life of your loan. You could check out the rules in Topic 504—Home Mortgage Points.

Though purchasing mortgage points can help you save significant money over the course of your loan, they may not be the right choice under certain circumstances. You need to ask yourself if you have the cash available to buy points in addition to your down payment, reserves, and closing costs. You also need to determine if you will own the home long enough to recoup the cost of the mortgage points.

You owe it to yourself to get the best deal possible as this is one of the largest loans you will probably ever avail of. So, if you have any queries or need help to crunch the numbers consult our mortgage expert today.