A new home is often the most expensive purchase you’ll ever make – and not just because of the price of the home, but all the costs that accumulate along your home buying journey – from the time you spend looking and searching for your new home and researching locations to applying and negotiating your loan, mortgage rate and closing costs.
Being able to reduce, lower, save time or money on even just one of these costs would be a huge help in the home buying process.
Mortgage points can help you save money by lowering your mortgage interest rate – so that over time – you will pay less in interest than you would have otherwise.
Mortgage points aren’t something most of us deal with on an every day basis, and how points on a Mortgage work can often be a mystery – but knowing more about how mortgage points work, their costs and benefits, could be crucial in deciding whether or not mortgage points could be a fit for your unique financial position.
What are Mortgage Points?
Mortgage Points (also known as mortgage discount points) are one-time fees a home buyer can pay to a lender when closing on a home to lower or reduce their mortgage interest rate.
Typically bought in 0.25% increments, buying down your interest rate with mortgage points can help you pay less and save money on the amount of interest you pay on a loan over time.
So while these points have no affect on the principal balance of your loan, being able to reduce your mortgage rate by even a little could help you save a significant amount of money in the long run when paying off your loan.
In short, you are paying a little more now to save a lot more further down the road – and the longer you intend to own your home, the more you will save on interest when you invest in mortgage points.
How Mortgage Points Work
When it comes to mortgage points, there are actually two types you might see, and while they may sound similar and are both paid at closing, they are two very different things.
Mortgage Origination Points
Origination Points represent the fees lenders charge for creating your loan, including evaluating, processing, and shepherding it through approvals. These points vary among lenders, but in essence, they are added into your closing costs.
Mortgage Discount Points
Discount Points represent interest that you pre-pay on your loan. In effect, you spend a little more upfront to pay less interest later.
The more Discount Points bought, the lower the interest rate on the mortgage. Depending on how much you would like to reduce your interest rate, you might pay between 0 and 3 points.
How much do Mortgage Points cost?
While it can vary between lenders, on average, every discount point you buy costs approximately 1% of the loan, and can possibly lower your interest rate by up to .25% percent for each point you buy.
Points can often be purchased in increments down to eighths of a percent, or 0.125%.
How to calculate Mortgage Points
It’s easy! Since each point equals 1% of your home loan amount, the more you borrow, the more your Mortgage Points will cost.
You pay $1,000 for every $100,000 you spend, $2,000 for every $200,000, and so forth. On a $400,000 home loan, a half point would cost $2,000.
Example: How Mortgage Discount Points Reduce Interest.
The more points you pay upfront the less you pay over the life of the loan.
Let’s say you take out a $200,000 30-year fixed-rate mortgage at 5.125%.
At an interest rate of 5.125% over 30 years – and without paying down the loan early – the cost of the loan would be $392,028.20.
However, what if your lender offers an interest rate of 4.75% if you purchase 1.75 Discount Points upfront?
Since each point on a $200,000 loan costs $2,000, this means 1.75 points will cost $3,500; but you’d end up paying $375,480 over the life of the loan.
The result of paying these points upfront? You may save $16,549.20 in interest – or about $45.97 per month over the life of the loan.
What’s a break-even point and why does it matter?
When buying mortgage points, the break even point is a major milestone in the life of your loan. The break even point is the point in time where the savings you received from buying mortgage points equals the cost you paid for them.
After the break even point is when you can begin counting the actual savings from the lower interest rate.
How to Calculate the Break-Even Point
To calculate the break-even point you have to divide the amount you paid for the points by the amount you would save on your monthly payment.
To calculate the number of months until break-even:
Break-Even Point = Mortgage Point Cost/Monthly Savings
To get the number of years you can divide that number by 12 or do:
Break-Even Point = Mortgage Point Cost/(Monthly Savings*12)
So, continuing from the calculations and example above – the way you would calculate the break-even point is by taking the total amount or cost you paid for the points – in this case $3500, and then divide that by the monthly savings on interest, which would be $45.97.
The Break Even Point = $3500/$45.97 =76.14 Months
Divide by 12 and you will get the number of years, in this case 6.34, which is about 6 years and 4 months.
Or to calculate directly as years:
Break-Even Point = $3500/($45.97*12) = 6.34 years
Why The Break-Even Point is Important
The break-even point is important as it helps you find the point in time when you will start to see the actual savings on your loan from your purchase of mortgage points.
The longer you keep your home, the more savings on interest you will see – but if you intend to refinance or sell before hitting that break-even point, you might be better off steering clear of Mortgage Points, as you won’t see or realize the actual savings until you reach that break-even point.
What are the main benefits of Mortgage Points?
As we have seen, if you can afford the extra upfront cost, investing in mortgage points can often be a huge benefit and place of savings over the course of your loan.
Main Benefits of Mortgage Points
- They lower your interest rate
- They lower your monthly mortgage payments
- They can help you save money in the long run over the course of your loan
What are some additional considerations when weighing the option of buying Mortgage Points?
Additional Considerations
- You’ll be paying more upfront, so your closing expenses are higher.
- You might prefer to pay down other debt instead. Your decision depends on your financial position.
Mortgage Point FAQs
Lenders have caps on how many Mortgage Points you can buy. The typical range is 0 to 3 points.
The cost of 1 mortgage point approx. = 1% of the total mortgage amount.
On average, 1 mortgage point is worth a 0.25% reduction in your mortgage interest rate, but this reduction in interest rate can vary depending on your lender, offers, incentives, or individual circ*mstance.
Buying points can serve a number of purposes. While you pay more upfront, points can be worthwhile if you need to lower your monthly costs; if you’d like your tax deduction upfront; or if you plan on keeping your home long-term.
No, mortgage points do not reduce or have any effect on the principal amount of your loan. Mortgage points only affect the mortgage interest rate.
Yes, but the Discount Points you buy will only apply to the initial fixed rate period which can be 5-10 years so it’s extra important to pay attention to your break-even point.
Discount points are tax deductible; Origination Points are fees, so they are not.
At K. Hovnanian Homes, with meticulous attention to detail and excellent customer service, we take pride in building beautiful new construction homes and communities across the nations – with a wide offering of homes and designs, you can be sure to find a new home to fit both your lifestyle and your budget.
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Sources:
– IRS.gov
– ConsumerFinance.gov
Last Updated on March 12, 2024
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