Mortgage points explained, to pay or not to pay?
Taking the time to understand mortgage points, discount points or origination points and you might be able to save a bundle on your mortgage over the course of your loan.
It’s no surprise that mortgage/discount/origination points are often not fully understood by buyers. After saving up for a down payment and adding in closing costs and other fees, spending a few more thousand dollars for points doesn’t seem worth it. Unfortunately at this point in the house-buying process after dealing with purchase contract, repairs, inspection, documentation and other stuff, most buyers just want to finish the transaction and aren’t motivated to educate themselves on points.
So the big question is quite simply, ”Is the expense of paying any points worth it? The simple answer is “maybe”!
But before we try to answer the questions, we need to explain what exactly are points.
What is a mortgage point?
Mortgage points actually refer to two different things: loan origination fees and discount points. In essence paying any type of point is like prepaying interest in today’s dollars to get a lower interest cost over the life of the loan. Each point equals 1% of the amount of the loan. So 1 point on a $200,000 loan is $2000. The trade-off between paying points to get a lower interest rate is not a 1-1 relationship. Meaning if you agree to pay 1 point you do not get a reduction of 1% on the interest rate. Paying 1 point may only get you a ¼% decrease on your interest rate. You lender should be able to provide you options so you can find the sweet spot, meaning the most “bang for your buck”.
Why would you want to purchase points?
Quite simply it is a guess on the part of the buyer on how long they will keep the loan. On the example above it might take you 4-5 years to recoup the upfront charge of $2000 with the reduction in the mortgage payment. But after that break even period you would be saving money. In the past though when interest rates kept falling, many borrowers refinanced prior to breaking even and took out new loans with more points. So in that case the lenders came out ahead. In a market like today’s where rates are expected to rise, it may be a good choice since the likely hood of refinancing for a lower rate is less.
Points are tax deductible. Yup Uncle Sam will help finance your points
Because points are interest-payment related, they are fully deductible on your taxes in the year that you close on a purchase. For a refinance, the deduction still exists, but must be spread out over the duration of your loan. If your refinanced last year be sure to look back to see if you paid points on previous loans. Then talk to you accountant who may be able to saving you some money.
Are they a good idea?
Again this is a very personal decision and everyone will have an answer. It really comes down to how long you will keep your mortgage or how long you think you will. It’s really a financial one, rather than an emotional one. So you just need to do the math.
Generally speaking, it takes about four to six years to recoup the cost of paying for a point. There are many excellent online calculators that can help you to figure out the details for your specific situation. Just simply plug in your numbers and the break even analysis should pop out.
Make sure that you take the time to investigate your options. Looking for home, completing the purchase contract, doing inspection and gathering paperwork can all be very stressful. Don’t overlook this detail that may end up saving you a lot of money.