Should I Pay Points on My Home Loan?
What are points and how do they relate to your home mortgage? Whenever you take out a home mortgage, even if you’re just refinancing an existing home loan, your lender will most likely charge you “points.” Each point is equal to 1 percent of your mortgage amount.
Let’s look at an example. If you need a mortgage of $200,000 to buy a house, 1 point will be equal to $2,000. Lenders can charge as few or as many points as they wish, and they don’t have to be round numbers. For instance, they can charge 1.5 points.
Your points are listed on your loan estimate, a document you get from your lender after you apply for a mortgage. They should also be itemized on the closing disclosure. In this guide, we’ll debunk the two types of mortgage points as well as discuss whether you should pay points on your home loan.
Two Types of Mortgage Points
There are two different types of mortgage points given by lenders. The first type is known as discount points. These are actually any prepaid interest on your mortgage loan. That’s why when you use points to pay, this is sometimes called “buying down the rate.”
The more points you pay, the lower your interest rate is on your mortgage loan. Borrowers usually have the opportunity to pay with several points if they want to reduce their rate, but this will depend on your lender’s price structure.
Another type of mortgage point is known as origination points. These cover the lender’s cost of processing the loan. Essentially, they pay closing costs, and they’re also negotiable. These are often sometimes called “maximum loan charges” or “loan discounts.” Don’t be afraid to ask about these when you’re shopping for a mortgage.
Should You Buy Points?
Now that you understand the different types of mortgage points, let’s talk about when you should consider using them. Many new buyers find themselves asking “Should I use points on my home loan at all?” In reality, it depends.
You’ll need to consider first how long you plan to spend in the home, and how much money you’re putting down at closing. If you intend to move in a few years, buying points might not be a smart investment. Buying down your rate through discount points is a good long-term decision, but not always a good short-term decision.
The more you pay upfront with points, the lower your ongoing payments will be. If you do have extra cash to add to your downpayment, buying down the rate will lower your ongoing payments. If you’re buying these points yourself, they count as tax deductible in most cases.
A good way to get a clear picture of your best financial option is to use a mortgage points calculator. From here, you’ll know if purchasing discount points will actually pay off in the long-run. The general rule-of-thumb is that the longer you keep the mortgage, the more money you’ll save by paying with points.
When shouldn’t you pay with points? In general, it won’t work in your favor if:
- You plan to sell the home before your break-even point which could take several years
- You don’t have any extra cash to put towards buying points
- The monthly savings after your break-even point are not significant
The best thing you can do is ask your lenders to give you two estimates. One should be if you buy points and the other without points. This will give you a clear glimpse into which option is best for you. As we said before, there’s no one-size-fits-all solution. Like most things in life, you’ll need to do the math yourself to determine what’s best for your budget.