December 24th, 2018 9:06 AM by Jackie A. Graves, President
FREEHomePurchaseAnalysis Today'sMortgageRates FREEHomeRefinanceAnalysis
Should you buy points when you take out a
mortgage? Find out here how points work and the simple math to do to see if
buying them makes sense.
When you apply for a mortgageOpens a New Window.,
there are a lot of decisions to make. One thing you'll need to determine is
whether it makes sense to buy points.
Mortgage points, or
discount points, are fees you pay your lender in order to reduce -- or buy down
-- your mortgage rateOpens a New Window..
By lowering your interest rate, you reduce the monthly payment you make and you
also reduce the total amount of interest you pay on your loan.
Buying points can make sense
for many home-buyers, but you need to consider how long it will take you to
break even on the initial fees that you pay per point.
If you don't plan to stay in
your home long enough for your reduced interest rate to cover the cost of the
mortgage points you paid for, it doesn't make sense to pay points. If you do
plan to stay in your home long enough, you'll often end up saving more on
interest over time than the points cost you to buy.
Buying mortgage points
When you buy points, you pay a
specific amount of money to your lender in order to get an interest rate
reduction. Typically, each point you buy will cost 1% of the total amount of
your mortgage. So, if you were borrowing $200,000 and you wanted to buy a
point, you'd pay $2,000.
Typically, each point you buy
reduces your interest rate by .25%. For example your interest rate might go
from 4.5% to 4.25% if you paid for one point on your mortgage. However, the
specific amount your interest rate is reduced will vary depending upon your
lender and loan program.
If paying 1% of your mortgage
to buy a point seems unaffordable, your lender may also allow you to buy
half-points. These obviously cost less, and would reduce your interest rate by
less. Buying half a point would cost you .5% of the loan amount and would
reduce your interest rate by 0.125%.
Points may be tax deductible
When you buy points on your
mortgage, this is considered to be “prepaying interest.” As a result, you are
typically able to deduct the amount you paid for the points from your federal
However, the amount you're
allowed to deduct will vary based on how much your mortgage is. If your
mortgage is not fully tax deductible because you're borrowing too much money to
fall within the IRS limits, you will only be able to take a partial deduction.
As of 2018, for newly initiated
mortgages, the maximum loan value in order for interest to be fully deductible
is $750,000. If you borrow more than this amount, you'll only be eligible for a
The IRS also indicates you must
meet certain requirements to take either a full or partial deduction for points
you buy. You can deduct points in the tax year they are paid if:
The mortgage is for your primary
home, or for the home you live in most of the time.
You didn't overpay for points and
paying for points is an established business practice in your area.
The money you brought to closing,
including any seller-paid points, was at least as much as the cost of the
points. You aren't able to deduct the cost of points if you borrowed the money
to pay for points from your lender or mortgage broker.
Is it worth buying points?
When you consider whether to
buy points or not, you need to do a little math to see when you would break
even from the purchase. For example, say you were taking out a $250,000 loan
and you had a choice between buying 0 points with an interest rate of 4.5% or
buying one point and reducing your interest rate to 4.25%.
If you did not buy points, your
monthly payment on a 30-year mortgage would be $1,267 and the total cost of
your loan would be $456,071.
You would save $37 per month if
you paid for a point -- which would cost you $2,500 (1% of $250,000). To
determine how long it would take you to break even for buying points, you'd
need to divide $2,500 (your cost) by your monthly savings of $37. Based on this
calculation, you'd break even or make up for the $2,500 you spent on the point
in 67.6 months.
If you remain in your home for
longer than 67.6 months, then you're better off for having bought the points
because you've made up for your initial $2,500 investment and you continue to
enjoy payments that are $37 lower every month.
If you stay in your home and
keep paying off your mortgage for 30 years, you'll pay a total of $13,325 less
in interest. Even after subtracting for your initial $2,500 investment in
buying the point, you end up saving $10,825 over the life of the loan.
That's a substantial amount of
savings -- but of course you only realize it if you remain in your home. If
your future is not certain and you don't think you'll be staying long enough to
break even, you may not want to incur the initial cost of buying the point.
Make sure to comparison shop carefully
It's important to understand
mortgage points not only so you can decide if it makes sense for you to buy
points or not, but also because you want to make certain you're comparing
apples-to-apples when you take out a mortgage loan.
If one lender is offering you a loan at 4.5% with no points and the other offers you a 4.5% loan
with one point, obviously the first loan is a much better deal. With the second
lender, you'd be paying 1% of the entire cost of your mortgage just to get the
same rate the first lender is giving you for free.
Some lenders also offer negative mortgage
You also have the option with some lenders to apply negative points to your mortgage. Essentially,
this means you increase your interest rate in order to get a credit that you
can use to cover closing costs.
For example, if you were taking
out a $250,000 mortgage and you applied a negative mortgage point, your
interest rate might rise from 4.5% to 4.75% -- but you would get a $2,500
credit to cover costs at closing.
While negative points make your
home cost more over time, they can sometimes make it possible to afford to
close on a home when you otherwise would be tight on cash. Just be aware that
this option is costly.
In the above example where you
raised your rate from 4.5% to 4.75%, your $250,000 loan would result in a
monthly payment of $1,304 and the total cost of your mortgage would be
When compared with a monthly
payment of $1,267 and a total cost of $456,017 if you hadn't applied negative
points, you pay $37 more each month and would pay $13,466 more over 30 years in
exchange for having gotten $2,500 up front.
Do the math on buying mortgage points
Whether you consider buying
points to reduce your rate or applying negative points to get cash up front,
make sure to do the math to understand the long-term impact your choice will
have on your mortgage costs. Your mortgage is probably going to be your largest
debt with the biggest monthly payment, so you owe it to yourself to get the
best deal possible.
Source: To view the
original article click here