What are mortgage points and how do they work?

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There’s a lot to learn when it comes to buying a home, especially if you’re going through it all for the first time. While you might already know some of the basics, like what a down payment is or how lenders’ fees work, other topics like mortgage points might not be covered until you get to the bottom of it. home buying process.

Below, Select takes a closer look at what mortgage points are and how they can potentially save you big bucks over the life of your loan.

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What are Mortgage Points?

Mortgage points are fees a homebuyer can pay upfront in exchange for a slightly lower interest rate. This is also known as “lowering the rate” and is something that could potentially save you a lot of money over the life of your loan.

As with any other form of debt, interest charges can really eat into your budget and make it more expensive to borrow money — especially when you have to take out such a large loan to pay for your home — so it’s easy to see why buying mortgage points can help you save money in the long run.

How do mortgage points work?

A mortgage point will typically cost 1% of your loan amount and reduce your interest rate by approximately 0.25%. If you were to take out a $200,000 loan, for example, one mortgage point would cost $2,000 and earn you a 0.25% reduction in your interest rate, while two mortgage points would cost $4,000 and reduce your interest rate of 0.5%.

The cost of each mortgage point depends entirely on the amount of your loan — in other words, the the higher your home loan, the more you will have to pay for each of them. Keep this in mind for budgeting reasons when determining how much money you will need to pay upfront to buy your home.

How much money can you save with Mortgage Points?

The amount of money you will save over the term of your loan depends on the amount of the loan you take out, the number of mortgage points you purchase in advance, the reduction in your interest rate and the duration of your loan. .

Bank of America illustrates a savings example with a $200,000 loan at 4.5% interest over 30 years – in this case, no mortgage points were purchased, so the individual will pay $1,013.37 per month in interest and principal over 30 years. period. According to the example, however, if a buyer were to purchase a mortgage point for $2,000, they would reduce their interest rate to 4.25% and instead of having to pay $1,013.37 per month, they would only pay $983.88 per month. This represents a total of $10,616.40 in interest savings over the 30 year period. When you factor in the $2,000 cost of the mortgage point, you end up with a net savings of $8,616.40.

The amount of savings essentially doubles over the 30 year period when a homebuyer purchases two mortgage points instead of one – paying $4,000 up front for two mortgage points would reduce the interest rate to 4 % and would increase the monthly payment from $983.88 to $954.83. In 30 years, this buyer will end up saving $21,074.40. When you factor in the $4,000 cost of two mortgage points, you end up with a net savings of $17,074.40 over 30 years. In this example, it would take 68 months of payments to break even to cover the $4,000 cost of purchasing the mortgage points.

Of course, you’ll need to run your own numbers once you know how much borrowing you’ll need and what your interest rate will be – your lender can help you work out these calculations so you can better predict what your loan would look like. saving. As. Also, it may make more sense to put more money on the house than to buy mortgage points.

Is paying mortgage points worth it?

As we saw in the example above, mortgage points can save buyers a considerable amount of money in the long run. Plus, they can potentially offer tax benefits because you can deduct mortgage interest payments from your taxes. Buying points up front can be worth it if you plan to stay in the same home for the full term of your loan, or at least long enough for you to break even on the amount you paid. for them – don’t forget to ask your lender to help you calculate your exact break-even point.

If, however, you only plan to stay in the house for a short time, paying mortgage points up front may not be worth it. It also might not make sense if you plan to refinance your mortgage soon after purchase, because refinancing essentially replaces your current interest rate.

Purchasing mortgage points would be useful if you applied for your loan with a lower credit score, but were unable to secure a more favorable interest rate. Keep in mind, though, that these shouldn’t be treated as your Plan A when it comes to lowering your interest rate; mortgage points are best used in conjunction with a favorable interest rate, which you would get with a higher credit score.

It’s also worth considering if you have enough cash on hand to pay the mortgage points, as the down payment, closing costs, and other fees you’ll encounter during the home buying process can really pile up. On top of that, you’ll want to make sure you have enough money set aside for any immediate repairs or emergencies that may arise after you move in.

Finally, the money you use to buy mortgage points can be better spent putting more money down when you buy your home, because you’ll immediately have more equity in the house and need to borrow less money for the home. to buy. You can use a Mortgage Points Calculator to better understand where your money would go if you deposited more or bought Mortgage Points.

Keep in mind that mortgage points work best if you have a fixed rate mortgage. If you have a variable rate mortgage, it would only reduce your interest rate during the fixed rate period for the first few years, but would not apply to the rest of the loan, so you would have no long-term horizon to take advantage of these savings.

If you think you might be interested in buying mortgage points, talk to your lender to see if this is an option they offer. Lenders will typically have a variety of other terms and programs aimed at providing more flexibility to borrowers. For example, Ally Bank offers home loans with no lender fees, so you won’t have to pay to apply, originate, process, or underwrite. This can help borrowers save some money to spend on other home buying costs.

Allied bank

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed and adjustable rate mortgages included

  • Types of loans

    Conventional Loans, HomeReady Loan and Jumbo Loans

  • Terms

  • Credit needed

  • Minimum deposit

    3% if you continue with a HomeReady loan

Advantages

  • The Ally HomeReady loan allows a down payment of just under 3%
  • Pre-approval in just three minutes
  • Submission of the application in less than 15 minutes
  • Online support available
  • Existing Ally customers are eligible for a discount that applies to closing costs
  • Does not charge lender fees

The inconvenients

  • Does not offer FHA, USDA, VA or HELOCs loans
  • Mortgages are not available in Hawaii, Nevada, New Hampshire or New York

For those who reside in an area with a higher cost of living and need to borrow more money to buy their home, SoFi offers jumbo loans to finance up to $3 million.

SoFi

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed and adjustable rate mortgages included

  • Types of loans

    Conventional loans, jumbo loans, HELOC

  • Terms

  • Credit needed

  • Minimum deposit

Advantages

  • Quick pre-qualification
  • Provides access to mortgage officers for advice
  • $500 off for existing SoFi members
  • 0.25% price reduction when you lock in a 30-year rate for a conventional loan
  • Offers up to $9,500 cash back if you buy a home through the SoFi Real Estate Center

The inconvenients

  • Does not offer FHA, VA, or USDA loans
  • Mortgages are not available in Hawaii

At the end of the line

Buying mortgage points can be a smart way for homeowners to lower their interest rates and save money in the long run. That said, this method only makes sense if you’re planning on staying in your home for a long time – and if you have the extra cash on hand to buy them up front.

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Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.

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