Whether you are looking to purchase a new home or refinance an existing one, you want to make sure that you get the best price possible for your home. In order to do this, you should try to get the lowest interest rate possible. One way to achieve this is through mortgage points. At the same time, mortgage points might not always make sense for your mortgage loan. Therefore, it is important for you to understand what they are and how they work.
What Are Mortgage Points and How Do They Work?
First, you should understand what mortgage points are. In essence, this is a fee that you are going to pay upfront to the mortgage company to reduce the interest rate on your loan in the long run.
Traditionally, one mortgage point is going to cost 1 percent of the entire loan amount. For example, if you purchase a home for $400,000 and to take out a loan for $350,000, then one mortgage point is going to cost $3,500. The points are paid at closing and your lender is going to calculate any mortgage points that you request (or they order) as part of the loan agreement.
Now, the amount by which your loan is reduced for each mortgage point is usually up for negotiation. Usually, if you purchase a single mortgage point, this will provide you with a 0.25 percent interest rate reduction per point. For example, if your lender offers you a mortgage at 3.5 percent, you might be able to get this interest rate reduced to 3.0 percent by purchasing two mortgage points.
Even though it is always good to fight for a lower interest rate on your home loan, mortgage points are not always worth it. Therefore, you should think about when mortgage points are in your best interest.
When Should You Buy Mortgage Points?
Are mortgage points going to help you? Some of the key factors that you should consider if you are wondering whether or not mortgage points are right for you include:
- How Long Will You Live in Your Home: The longer you are planning on staying in your home, the more you are going to benefit from your mortgage points. The goal of mortgage points is to reduce your monthly mortgage payment. If you are only going to be staying in your home for a few years, this is probably not going to be worth it. On the other hand, if you are going to be in your home for 15 or 30 years, then Mortgage points might be worth it.
- The Break-Even Point: You should try to figure out when the amount of money you will save exceeds the amount of money that you spend on your mortgage points. Your lender, your real estate agent, or your financial advisor should be able to help you with this calculation.
- The Down Payment: In most cases, it is better to apply extra cash to your down payment instead of purchasing mortgage points. If you put more money down, this could provide you with a lower interest rate and help you avoid having to purchase PMI, which is private mortgage insurance. Mortgage points will not help you avoid PMI.
- Your Monthly Mortgage Payments: Mortgage points are only going to help you if you plan to pay your loan off over a longer period of time. If you plan to pay off your home quickly, mortgage points probably will not help you save that much money.
Even though mortgage points are a good idea for some borrowers, they do not make sense for everyone. In order for you to figure out how much money you can save with mortgage points, you need to think carefully about the numbers. Assess your budget, think about your down payment, and consider your future plans before you close.