When is it Smart to Buy Mortgage Points?

As mortgage rates rise and housing inventory is beginning to stall, many homebuyers ask whether they should buy mortgage points to secure a lower interest rate. Buying mortgage points is one way to lower your mortgage rate, but the decision can be difficult for many homebuyers. For new borrowers getting ready to buy a home and for homeowners who want to refinance, buying mortgage points is one option to reduce your rate and bring down a mortgage payment. But it’s not always the best option. 

Keep reading to learn the pros and cons of buying mortgage points.

If getting the lowest interest rate is your primary goal, then choosing to buy mortgage points or “discount” points can make a lot of sense. But paying mortgage points at closing isn’t always the best financial decision when it comes to saving money on your mortgage. It all depends on your financial goals.

The truth is there are a lot of factors: the terms of the loan, closing costs, how much money you want to use for a down payment, and how long you plan to stay in your home. An experienced mortgage advisor can help explain your best loan options to help you meet your financial goals.

Related: How to win the bidding war for new homebuyers in 2022

Are mortgage points and discount points the same thing?

There are two types of mortgage points: Discount points and rebate points. When people talk about paying mortgage points or buying mortgage points, they are typically referring to discount points. Mortgage points, or discount points, allow you to reduce your interest rate by paying your mortgage interest upfront.

Mortgage points typically cost 1% of your total loan amount. For example, for a $400,000 mortgage, 1 point would cost $4,000 (2 points would cost $8,000, etc.) In exchange, you’ll typically receive a reduced interest rate of 0.25% for each point.

Buying mortgage points can reduce your interest rate and monthly payment (how it works).

Sample loan for a fixed-rate 30-year home loan for $450,000:

• Loan amount: $450,000
• Loan term: 30-year fixed rate
• Interest rate: 6.00%
• Monthly payment: $2,698

Sample scenario if you decide to pay 2 mortgage points:

• Loan amount: $450,000
• Loan term: 30-year fixed rate
• Mortgage points: 2
• Reduced interest rate: 5.50%
• Lower monthly payment: $2,555
• Monthly savings: $143/mo
• Break-even period: 63 months
• Cost at closing: $9,000

In short, this means that paying 2 mortgage points (0.25% discount per point) would cost $9,000 (2% of the loan amount). Paying 2 mortgage points would reduce your mortgage payment by $143/mo and take 63 months to “break-even” or recover that cost. On month 64, you’d start the real benefits of a lower monthly payment.

The example above offers a framework to evaluate if paying points might be a smart decision.

Related: How to FAST TRACK your mortgage pre-approval

Is it always worth it to pay points on a mortgage?

Yes and no. In the example above, you can see how paying mortgage points upfront can save you money on your mortgage over the long term. But if you end up selling your house or refinancing in the short-term, paying mortgage points could end up costing money upfront at closing that you won’t recover.

Similarly, if you need the additional cash for emergency funds, home repairs, or other needs, it’s probably not wise to become cash-poor just to save 0.25% on your mortgage interest rate.

Today, with mortgage rates inching up and inflation rising, it can be a smart move to buy mortgage points and get a lower mortgage rate. Especially if you plan on staying in your home for more than 6 years, you could save thousands on interest over the life of the loan.

Is it smarter to make a bigger down payment instead of buying mortgage points?

Let’s say you have $9,000 in additional funds that you want to put toward your new home loan, and you’re not sure if you should buy mortgage points or put it toward your down payment.

Going back to the example above, you could put the $9,000 toward your down payment, reducing your home loan to $441,000. While this might not seem like a substantial difference, it would lower your monthly payment since your loan amount is lower.

What’s more, by increasing your down payment, you can improve your loan-to-value (LTV) ratio. A better LTV can translate into a lower interest rate or better terms. If your down payment crosses the 20% threshold, you’ll save even more.

The truth is, talking with a local mortgage advisor can help. Several factors affect every mortgage application, such as your credit score, debt-to-income ratio, and income verification. Custom loan options can create the best terms for your financial situation. Together, these factors impact the overall terms of your loan offer. Paying mortgage points is one element in a much bigger picture.

Related: How to refinance a mortgage without an appraisal fee

Are mortgage points tax deductible?

Mortgage points are tax-deductible in most circumstances. Mortgage discount points are prepaid interest on your mortgage and are treated the same as mortgage interest on your tax return. Note that the Tax Cuts and Jobs Act of 2017 puts a limit on the amount of mortgage interest you can deduct, so it’s best to check with your tax accountant for current limits and tax laws.

Finally, a few questions to consider:

Do you plan on staying in your home for at least 5 years (or longer than the break-even period)?

If you plan to move or refinance in less than 5 years, paying points might not be beneficial. But if this is going to be your forever home, it might benefit you to pay points for a reduced interest rate.

Do you have enough cash to make a substantial down payment and also pay points?

If not, it might be better to focus on your down payment. By making a larger down payment, you’ll have a smaller loan amount and a lower mortgage payment.

Is there a better way to invest your money instead of buying mortgage points?

In the example above, you’d pay $9,000 in points when your loan closes. Consider whether or not there may be an alternative way to invest that $9,000 which could yield better returns.

Check out a mortgage calculator to see what you can afford and if paying points will help meet your homeownership goals.

Takeaway

Paying mortgage points is a clear path to getting a lower interest rate and saving money if you plan to stay in your home long-term. That said, paying discount points in addition to a down payment and other closing costs can be financially demanding.

Before you deplete your savings, talk with a local mortgage advisor to find out how much you’ll save each month and how long it will take before you break even. Finally, if you have the extra cash, consider making a larger down payment which might generate better loan terms and save you more money than buying mortgage points.

Connect with a local mortgage advisor and discover which options will help you meet your financial goals.

Related: Compare the benefits of Renting vs. Buying in 2022

Next Steps

Working with a local mortgage advisor can help you compare your best mortgage options, lock in the lowest mortgage rate, and secure the best home loan that fits your life goals. Once you know your home loan options, you can decide whether or not buying mortgage points is a smart path. Connect with a local mortgage advisor to discuss your options and save money on your mortgage. We’d love to help.