February 9th, 2015 5:59 AM by Jackie A. Graves, President
When your lender gives you an interest rate, it’s not necessarily the one you have to stick with. You can raise or lower your interest
rate by buying something called mortgage points.
There are two types of points: one that lowers your interest rate
slightly but increases costs at closing, and one that raises your interest rate
slightly but reduces costs at closing. In this post, we’ll address discount
points (also known as positive points).
How you use discount points can save you thousands of dollars—or
it could end up costing you a pretty penny. You want to do the former—here’s
Discount points are a kind of prepaid interest: You pay
your lender an upfront fee at closing for a lower interest rate. One point
typically amounts to 1% of the loan amount. So one point on a $250,000 mortgage
would equal $2,500.
Lowering your interest rate
The primary purpose of buying discount points is to reduce your
interest rate. A point usually amounts to an interest rate reduction of 0.125%
to 0.25%, depending on the lender’s terms, although 0.25% is typical.
For example, if you bought a 30-year, $400,000 loan at an
interest rate of 5%, you would pay $2,147 in mortgage payments a month (not including taxes,
insurance, or anything else). Paying two points at 0.25% per point would lower
the interest rate to 4.5% and drop the monthly payment to $2,027. You would
also need to foot the upfront cost of $8,000 to buy those points at closing.
Using points the right way
You have to consider how long you think you’ll stay in your
house. Generally, if you buy points, you want to stay longer to recoup the
money it took to buy the points. If you sell the house too
soon, you won’t recoup the costs and can lose money.
Let’s go back to the above example of the 30-year, $400,000
loan. The two points for $8,000 at closing saves you $120 a month in mortgage
payments. It would take about 5.5 years before you recouped that $8,000
and started to actually save money.
However, it would also save you $43,394 in interest over the
life of the loan. Deduct that $8,000 in point-buying costs from money saved in
interest and you will have actually saved a total of $35,394. Of course, that’s
if you see out the life of the loan. If you sell after six or seven years,
buying those points wasn’t worth it. Know your future plans and move
Tax breaks and factors
It’s not just about saving money in interest and recouping
costs. Another factor is what you could have done with the discount point money
had you invested it elsewhere.
Another significant factor for some people is that discount
points, because they’re a form of interest, are usually 100% tax-deductible on
the year you buy your home. Those with heavy tax burdens may find this
deduction offsets the cost of buying points to begin with.
Plus, it’s not out of the question to have the lender foot the
bill and still benefit from it. If you strike a deal in which your lender
pays for your points, you can still deduct the cost of those points on your
taxes even though you didn’t directly pay for them.
You also have to weigh in your starting interest rate, loan
amount, and loan length. Generally, the bigger the mortgage, interest rate, and
mortgage length, the more money discount points will save you. Buying points on
shorter-term mortgages or those with very low interest rates could yield
savings of only a few bucks a month, so be sure to do the math.
By: Craig Donofrio | To view the original article