What are mortgage points and should you pay them? First let's discuss what mortgage points are. A point is equal to 1% of the total amount of the loan. For example, one point on a $400,000 loan is $4,000.Typically they are referring to discount points. Discount points are prepaid interest. Points expressed as a negative means a rebate is given while a positive number means it is a cost to buy the interest rate. You may see a rate sheet like this from a lender:
For a loan greater than $100,000, the limit is 3 points to buydown the interest rate. So, on our earlier example, you may pay up to $12,000 to lower the interest rate.
But is this a good idea? It depends on how long you plan to live in the home. So, let's say you are borrowing $400,000 on a 30-year loan. Using the above chart, paying 1 point,or $4,000 would lower your interest rate from 4.25% to 3.875%. This would lower your monthly payment by $85.92. To see if this makes sense for you, take $4,000 divided by $85.92,and you get 47 months. So, if you plan on staying in the home 4 years or more, it makes sense.If you're not planning on staying in the home that long, you would not recoup all the cost.
The interest rate reduction you will receive for buying points can vary widely, depending on the lender and the marketplace. The above rate sheet is just an example, each lender has their own rate sheet and it can vary from day to day as well.
Buying discount points may give you a tax benefit, depending on your specific tax situation.
You will avoid private mortgage insurance (PMI) by making a down payment of at least 20%. If deciding between making a 20% down payment and buying discount points, you would have to run the numbers or have your lender run the numbers to see what makes the most sense.
Points for adjustable-rate mortgages (ARMs) provide a discount on the loan's start-rate during the initial fixed-rate period. You want to make sure the break-even point occurs before the fixed-rate period expires. For example, on a 5/1 ARM, you would want to recoup your costs within two years.
In some markets, new home developers will offer to pay discount points as an incentive to homebuyers. This can work to your benefit, especially if you plan to stay in the home for a long time.
I hope this gives you some valuable information when you are ready to purchase a home. And when you are, I hope you keep me in mind as a real estate agent!