Mortgage Points Explained
Take the time to understand how mortgage points work and you can save a bundle on your mortgage over the course of your loan.
It's no surprise that mortgage loan points are often not fully understood by buyers. After saving up for a down payment and adding in closing costs and other fees, shelling out a few more thousand dollars for mortgage points doesn't seem worth it. At that point in the house-buying process, most buyers just want to finish the transaction and aren't motivated to educate themselves on points.
So, is the expense worth it? Unfortunately, the answer is "maybe"! If you plan to be in your house for any length of time, though, the answer is a bit clearer.
What do mortgage points mean?
Mortgage points actually refer to two different things: loan origination fees and discount points. Most of the time, discount points are what people mean when they talk about a mortgage with points. Discount points refer to the amount of money that a person pays to a lender to get a loan at a specific rate. These points are a way of pre-paying interest on the loan.
How do mortgage points work?
A person pays for mortgage points in order to get a lower mortgage rate. A mortgage point is not the same thing as a percentage point off of your rate. Instead, a point is equal to 1% of your loan. For example, if you have a $300,000 loan, a single point would cost $3,000. Two points would be $6,000. It depends on your lender, but in general, each point will take off about 1/4 to 1/8 of a percent off of your interest rate.
Mortgage points are tax deductible.
Because discount points are a form of mortgage interest, they are fully deductible on your taxes in the year that you close. If you are refinancing a mortgage, the deduction must be spread out over the duration of the loan.
Are they a good idea?
Before you can even consider whether or not paying mortgage points is a good idea, you have to make sure that you will have the extra cash at closing as you must pay for them front. The cost of mortgage points are not a fee you can finance.
If you have the money on hand, you should also consider how you might otherwise invest it. If you can get a greater return than the money that you will save on your loan, then you may be better off investing your money elsewhere.
Breaking Even
On the surface, paying for mortgage points may seem like an obvious choice, since you lower your mortgage rate. However, you really have to do an analysis to figure out if the cost is worth it. For that, you may want to use a mortgage points calculator to figure out how long it will take to break even.
Generally speaking, it takes about five to seven years to recoup the cost of paying for points, so if you expect to stay in the home and not refinance longer than that,
Mortgage points can add up to valuable savings over the course of your loan. Make sure that you understand them before you become so entrenched in the details of closing your mortgage that you don't have the bandwidth to consider them!
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