Mortgage Points: What They Are and How They Can Save You Money

Buying a home comes with many decisions, and one of the most significant choices you'll face involves your mortgage rate. I've noticed many homebuyers overlook a powerful tool that could save them thousands over their loan term - mortgage points. Let's explore how these little-known features work and whether they might benefit your financial strategy.

Mortgage Points: A mortgage point is a fee equal to one percent of the total loan amount that borrowers can pay to their lender at closing to reduce their interest rate. For example, on a $200,000 mortgage, one point would cost $2,000 and typically results in a lower monthly payment over the life of the loan.

Types of Mortgage Points

You'll encounter two main types of mortgage points during your home buying process. The first type, discount points, work like a prepaid interest charge - you pay more upfront to secure a lower interest rate. If you have a $300,000 loan and buy two discount points, you'd pay $6,000 at closing to reduce your rate.

Origination points differ from discount points - they're fees charged by lenders to process your loan. Unlike discount points, origination points don't lower your interest rate. You can often negotiate these fees with your lender, especially if you're comparing offers from multiple mortgage providers.

The Math Behind Mortgage Points

Let's crunch some numbers. Say you're looking at a $250,000 mortgage at 4% interest. One point costs $2,500 and reduces your rate by 0.25%. Your monthly payment would drop from $1,194 to $1,158, saving you $36 monthly.

To find your break-even point, divide the cost of points by your monthly savings:

• Break-even formula: Point cost ÷ Monthly savings = Months until break-even

• Example: $2,500 ÷ $36 = 69.4 months (about 5.8 years)

Strategic Considerations

Your decision to buy points should match your long-term plans. If you'll keep your home beyond the break-even point, points might make sense. But if you plan to move or refinance sooner, skip them.

Consider your cash reserves too. While points lower your monthly payments, they require more money at closing. Make sure buying points won't drain your emergency fund or leave you cash-poor after moving in.

Current market rates play a role too. If rates are already low, the reduction from points might be minimal. The tax benefits vary - consult your tax advisor about deducting points on your return.

Common Misconceptions

Let me clear up some confusion about mortgage points:

• Points don't always save money - it depends on how long you keep the loan

• The rate reduction varies by lender - one point rarely equals a full percentage point reduction

• You can negotiate points with lenders, just like other loan terms

Making the Decision

Ask your lender these questions:

• How much will each point reduce my rate?

• What's my monthly payment with and without points?

• Can you provide a complete breakdown of closing costs?

Consider other rate-reduction strategies too, like making a larger down payment or improving your credit score before applying.

Real-World Examples

Short-term scenario: If you plan to sell in three years, paying points on a $300,000 loan probably won't pay off. You'd spend $3,000 per point but might only save $1,800 in payments before moving.

Long-term scenario: Planning to stay 15 years? That same point could save you $9,000 over the loan term - triple your investment.

Conclusion

Mortgage points offer a trade-off: pay more now to save later. They work best for long-term homeowners who have extra cash at closing and want to minimize monthly payments.

Bellhaven Real Estate's mortgage partners can help you run the numbers and decide if points fit your situation. Contact us to explore your options and find the most cost-effective way to finance your home purchase.