There are many things to think about when you buy a house, such as the interest rate and type of mortgage you want. Buying mortgage points to lower your rate is another thing to think about. Here’s more about points, including what they’re good and bad for and how to find the breakeven point.
What are the points of a mortgage?
You can use mortgage points in two different ways to lower the cost of your mortgage. Interest rates on mortgages can go up or down. Origination points are used to pay the lender for making the loan, while discount points are used to lower the interest rate. Find out what points are and how they work for bank loans.
How do they work
Loan points come in two types: discount points and acquisition points. In either case, one point is usually equal to 1% of the total loan amount. Take the case of a $300,000 home loan – one point is equal to $3,000.
The written loan quote and closing statement from the lender list both types of points as closing costs.
Origination Points
Origination points pay loan officers for their work. Origination points are not always required by mortgage lenders and those that are usually ready to work out a deal on the fee. Origination points are not tax-deductible, and a lot of lenders no longer offer origination points. Instead, they offer flat-fee or no-fee mortgages.
Discount Points
Prepaid interest is what discount points are. The interest rate on your mortgage usually goes down by up to 0.25% when you buy each point. It is possible to buy anywhere from a fraction of a point to three discount points from most lenders.
The Tax Cuts and Jobs Act (TCJA), which went into effect in 2018, says that starting points are not tax-deductible.
From now on, discount points can be written off, but only on the first $750,000 of a loan. Along with that, the standard credit is higher, so it’s best to talk to a tax professional to see if buying points could help your taxes.
Keep in mind that when lenders show rates, they might show a rate that changes if you buy points.
How to figure out discount points for mortgages
When deciding whether to pay for discount points or not, there are two main things to think about.
The first thing to think about is how long you plan to stay in the house. When it comes to discount points, the longer you plan to stay, the more you can save.
The second thing you should think about is whether you have enough cash to pay the mortgage points. There isn’t enough money left over for many people to buy points after paying for the down payment and closing costs on their new homes.
On a $100,000 home, for example, three discount points cost only $3,000. On a $500,000 home, on the other hand, they cost $15,000. A 20% down payment of $100,000 for a $500,000 house may be too much for the buyer to pay. An extra $15,000 may not be possible for them.
How to pay for discount points
Think about this example of a 30-year loan:
- That’s how much you’d pay each month for capital and interest on a $100,000 loan with a 3% interest rate.
- Your monthly payment would be $382 if you bought three discount points. Your interest rate would be 2.25%.
You would save $39 a month if you bought the three discount points, which cost $3,000. To get your money back from the point buy, you would have to keep the house for six years, or 72 months. If you plan to stay in your new home for a long time, buying points would be a smart move since a 30-year loan lasts for 360 months.
Not so if you only plan to stay for a few years. You might want to buy fewer points or none at all. Depending on how long you plan to own the home, there are a lot of tools that can help you figure out how many discount points you should buy.
Are points on a mortgage worth it?
People who pay discount points could invest that money in the stock market and get a higher return than the amount they saved by paying the points. However, the fear of getting into a mortgage they can’t afford can make them less likely to do so than the possible benefit they could get from making the right investment. A lot of the time, paying off the debt is more important.
Additionally, remember why you want to buy a house. Even though most people want their home’s value to go up, not many people buy a home just as an investment. From a business point of view, if the value of your home triples, you might not want to sell it because you would have to find a new place to live.
Most of the other homes in your area may also go up in value if yours does. If that’s the case, selling your house will only give you enough cash to buy another house for almost the same price. Also, if you take 30 years to pay off your mortgage, you will probably have paid almost three times the home’s original price in interest and capital. If you sell it for more than what you borrowed, you won’t make any money.
Conclusion
Origination points can often be avoided or negotiated, so don’t spend too much on them. In contrast, discount points can save you money throughout the loan. However, you can only buy them if you can do so without dropping your down payment below 20% and getting private mortgage insurance (PMI).
Key takeaways:
- Loan points come in two types: discount points and acquisition points.
- Origination points are a type of fee that buyers pay to the lender to process the loan.
- People who pay for a loan upfront can get discount points that lower the interest rate.
- A lot of the time, mortgage points are 1% of the loan amount.
- When you want to compare how much different loans cost, you can use the annual percentage rate (APR).
