Mortgage Points: Should You Pay These Optional Fees?
What Are Mortgage Points?
Mortgage points, also known as discount points, are fees paid upfront to a lender in exchange for a reduced interest rate on a mortgage. This process, often referred to as "buying down the rate," is optional and can help lower your monthly mortgage payments over the loan term. When shopping for mortgage rates, it's essential to understand that advertised rates may include one or more discount points. Be sure to inquire about the base rate without added points to make accurate comparisons between lenders.
How Much Does One Mortgage Point Reduce the Rate?
Typically, one mortgage point costs 1% of the loan amount and reduces the interest rate by approximately 0.25%. However, the exact reduction can vary depending on the lender, loan type, and prevailing market conditions. For instance, paying half a point (0.5% of the loan amount) might reduce the interest rate by about 0.125%. Conversely, paying more points (e.g., 1.5 or 2 points) can further decrease the interest rate, offering greater savings.
How Do Mortgage Points Work?
Paying for discount points lowers both the interest rate and the monthly payments on your mortgage. The amount saved each month depends on factors like the loan amount, interest rate, and loan term (e.g., 30-year vs. 15-year mortgage).
Example: Monthly Savings from Mortgage Points
Consider a $300,000 mortgage with a base interest rate of 7% over a 30-year term. Without discount points, the monthly principal and interest payment is $1,996. Paying for one or two discount points can significantly reduce this payment, as illustrated below:
Points Cost of Points Principal and Interest Monthly Savings Months to Break Even
0 points (7% interest rate) $0 $1,996
0-1 point (6.75% interest rate) $3,000 $1,946 $50 60 months
2 points (6.5% interest rate) $6,000 $1,896 $100 60 months
Should You Buy Points?
The decision to buy points depends on whether you can afford the upfront cost and if you'll keep the mortgage long enough to benefit from the reduced rate. The break-even point occurs when the total monthly savings equal the initial cost of the points. Beyond this point, you save money. However, if you sell the home or refinance before reaching the break-even point, you could lose money. The break-even point varies based on factors like loan size, interest rate, and loan term. Typically, it takes several years to reach this point, so it's crucial to consider how long you plan to stay in the home.
Can You Negotiate Discount Points on a Mortgage?
Yes, you can negotiate discount points. Lenders may include points in your loan offer to make the interest rate appear lower. When comparing offers, request quotes with zero points or the same amount of points from different lenders to make an accurate comparison. You can decide to buy discount points after selecting your mortgage lender, but not after closing the loan.
Can the Home Seller Pay Your Discount Points?
Yes, in a buyer's market, sellers might offer to pay for your discount points. This arrangement can save you money from the start, eliminating the need to calculate a break-even point.
Are Mortgage Points Tax Deductible?
If you itemize your tax deductions, you might be able to deduct the discount points paid on a mortgage for your primary residence. The deduction amount may be limited based on the loan amount and might need to be prorated over the loan's life. Even points paid by the seller on your behalf may be deductible. Consult a tax advisor for detailed information.
The Bottom Line
Mortgage points can be a valuable tool for lowering your long-term mortgage costs, but they require a careful assessment of your financial situation and future plans. By understanding how they work and considering your break-even point, you can make an informed decision about whether paying for points is right for you.
