Anyone who has ever applied for a mortgage has probably heard the term “mortgage points” or “discount points.”Perhaps you wondered exactly what these points were, and whether they are worth the cost to purchase them. We’ll review the basics on mortgage points, and when it makes sense to consider them in this two-part blog post.
The Basics: What is a Mortgage Point?
Mortgage points, which are sometimes called discount points, are essentially a fee that most lenders offer at the time of closing to lower your interest rate. When you purchase discount points or mortgage points, you get a lower interest rate for the entire life of your home loan. While the costs can vary, it usually costs about $1,000 per $100,000 of your loan, which will lower your interest rate by 0.25%.
For example, if you are trying to get a loan on a home that is $300,000 and your initial interest rate would be 4.5%, you could pay $3,000 for a rate of 4.25% instead. Having a lower interest rate will mean lower monthly mortgage payments, and less interest that you pay over the life of the loan, which are both great benefits. However, it’s important to weigh that against the up-front costs of purchasing the points to determine if it’s the right choice for you.
Calculating the Break-Even Point
To determine the “break-even point” of purchasing mortgage points, calculate the total savings per month as a result of your lower interest rate, then divide what you are paying for the points by that amount to see how long it takes to recoup the costs.
Example: You are purchasing a $300,000 house with a 5% down payment ($15,000).
- At your current rate of 4.5% your monthly principal and interest payments are $1,444
- If you purchase points to lower your interest rate to 4.25% your paymentsare $1,402
- It will cost you $3,000 to purchase the points
- With a $42 lower monthly payment, it will take about 72 months, or 6 years, to recoup that up-front cost
You can use a mortgage calculator to determine how much you will save each month with the lower interest rate. The break-even point calculation here is also simply dividing the total cost by monthly savings, which doesn’t take into account any opportunity costs of not investing that money elsewhere.
In part two of this post we’ll discuss when it might not be worthwhile to purchase mortgage points, and what other options you have for the cash you would have paid toward these points. Talk to Integrity First Lending today to determine which is the best choice for you.