Mortgage points, also known as discount points, are a type of fee paid by potential homeowners to lenders during the mortgage process. Understanding how these points work can help you decide whether or not they’re a good investment for your situation. Here’s an overview of what mortgage points are, how they work and when it might be beneficial to pay for them.
Mortgage points are a way for homebuyers to secure a lower interest rate on their loan. They’re essentially a form of pre-paid interest. Each point is equal to 1% of the amount of the loan. For example, one point on a $200,000 mortgage would cost $2,000.
There are two types of mortgage points: discount points and origination points. Discount points buy down your interest rate, while origination points cover costs associated with the creation of your loan, such as processing and administration fees.
How Do Mortgage Points Work?
Homebuyers have the option to purchase points when securing a mortgage. The more points you buy, the lower your interest rate will be. Typically, one point will drop your interest rate by 0.25%, but this can vary from lender to lender.
When deciding whether or not to buy points, you should consider how long you plan on staying in the home. If you intend to stay in the home long enough to recoup the cost of the points through your monthly savings, then buying points could make sense financially. However, if you plan to move or refinance before that time, purchasing points may not be cost-effective.
Benefits of Paying for Mortgage Points
The main advantage of paying for points upfront is the potential for long-term savings. By lowering your interest rate, you reduce the total amount of interest you’ll pay over the life of the loan. This can result in significant savings, especially if you plan to stay in your home for a long time.
Another benefit is tax deductibility. In the United States, the interest paid on mortgage points can be tax-deductible if they meet certain criteria established by the IRS.
When Should You Buy Mortgage Points?
Whether or not you should buy mortgage points depends on your individual financial situation and long-term plans. Here are a few things to consider:
- Longevity: If you’re planning to stay in your home for many years, buying points can be beneficial since the upfront costs are offset by the long-term savings from a lower interest rate.
- Finances: If you have the extra money at closing to pay for the points without causing financial strain, then it might be worth considering.
- Market conditions: In a low-interest-rate environment, the value of buying points can be less impactful. Conversely, in a high-interest-rate market, points can provide more significant savings.
Remember, it’s important to run the numbers and consult with a financial advisor or experienced mortgage lender before making this decision. Understanding mortgage points can help you make an informed decision about your mortgage and potentially save you money over the life of your loan.