You may have heard the term mortgage point thrown around if you’ve been shopping for a home loan. Not many borrowers fully understand this financial term. However, using points in the right situation can save you thousands of dollars over the life of your home loan.
What are mortgage points?
Mortgage points are best explained as pre-paid interest paid when you close on your house. By getting more money upfront, lenders have less risk on any given loan. Typically, lenders are more willing if points are paid upfront, to lower the interest rate, which means you pay less each month. Each point costs 1% of the loan. So, if you are borrowing 150,000 to buy your home, each point would cost you $1,500. Each point you purchase generally lowers the interest rate by 0.25%. That means by paying $3,000 for two points upfront on your $150,000 loan, you could reduce your 5.5 percent interest rate to 5 percent.
That 1/2 percent reduction might not sound like a big deal, but your $3,000 upfront investment would take your payment on a 30-year fixed mortgage from $851 per month to $805 each month. If you stayed in your home for the entire 30 years, then you would save $16,560 overall.
You can’t buy an unlimited number of points. Most lenders allow borrowers to buy between one and four points. Points are also tax deductible, assuming you itemize your deductions.
When paying points makes sense
Who wouldn’t want to pay $3,000 to save $16,560? Paying points doesn’t work for everyone. If you don’t expect to stay in your home more than a few years, paying points could actually cost you money. In our example, the homeowners would need to live in their house for 64 months to break even.
Paying points is a good option for homeowners who have significant savings, but are concerned about their monthly house payments in the future. Although by buying points, you’ll have a large lump sum to pay at closing time (in addition to the down payment, and the closing costs), you’ll know that you don’t have to come up with so much money each and every month for 30 years.
To find out more about mortgage points and how they apply to financing or re-financing your house, browse some of the other articles here that are available.