To Pay Or Not To Pay Mortgage Points – How To Decide
When mortgage rates rise, borrowers scramble to find ways to get the lowest possible interest rate. One option is to pay mortgage points to “buy down” your interest rate.
“Buying down” the rate means paying extra fees to your lender (these are called “discount points”) to get a lower interest rate and payment.
When interest rates are very low (as they’ve been in the last few years), few borrowers pay higher closing costs to go even lower. But as mortgage rates rise, borrowers are more likely to weigh the pros and cons of paying points to lower their mortgage rate.
The decision to pay or not pay mortgage points depends on several factors, and ultimately comes down to simple math.Verify your new rate (Dec 8th, 2019)
How Paying Mortgage Points Works
A mortgage point or discount point is equal to one percent of your loan amount. That’s $4,000 for a $400,000 mortgage. Essentially, you prepay interest upfront in exchange for a lower mortgage payment.
The rate reduction you get per point depends on your loan and market conditions. Typically, for a 30-year fixed-rate loan, a discount point gets you a .125 percent to .25 percent lower mortgage rate.
However, the relationship between discount points and interest rate reduction is not perfectly symmetrical. Even for the same loan.
How To Shop For Loans With Mortgage Points
As of this writing, for instance, one national lender offers a 30-year fixed loan at 4.5 percent with no points. You can knock .25 percent off that and get 4.25 percent by paying half a discount point.
But a 4.125 percent rate (just .125 percent lower) costs an additional point. Paying more doesn’t necessarily get you a better deal.
When shopping for a mortgage with discount points, the easiest way to compare offers is to decide how much you want to spend, then see who offers the lowest rate at that price.
Alternatively, you can decide what rate you want, and see which lender charges the least for it.
Why Pay Mortgage Points
If your income is too low for you to qualify for the house you want, you may be able to qualify with a reduced interest rate and payment.
If you have the cash available, or if you can convince a home seller to pay discount points for you, buying down your rate may help you qualify for your mortgage.
Paying mortgage points can save you money over the life of your home loan if you don’t sell or refinance for many years.
Understand, though, that the upfront investment can be substantial.
Suppose it costs two points ($8,000) to reduce the interest rate on a $400,000 30-year fixed-rate loan from 4.5 percent to 4.0 percent. Your monthly payment for principal and interest would be $117 lower with the lower rate ($1,910 instead of $2,027).Verify your new rate (Dec 8th, 2019)
Doing The Math
Should you pay the points if you keep your house for five years? You can figure it out by using a mortgage amortization calculator.
After five years, with the 4.0 percent loan, you’ll have paid $76,370 in interest, plus $8,000 in mortgage points, for a total of $84,370. You’ll have reduced your principal balance by $38,210.
With the 4.5 percent loan, you’ll have paid $86,236 in interest. You’ll have reduced your principal balance by just $35,368.
In this case, then, it will cost you $1,888 less over five years if you pay the discount points. But that’s not all. You’ll have reduced your balance by an extra $2,842. So your total savings in five years is $4,730.
One more advantage of paying mortgage points is that, since they represent prepaid interest, they are typically tax-deductible
Disadvantages Of Paying Mortgage Points
While lower monthly payments and potential savings over the life of your loan are clear benefits of paying mortgage points, there are some reasons you may be better off not paying discount points.
First, paying one or more points ties up your cash. If you’re making a down payment of less than 20 percent or have less than 20 percent in home equity when you refinance, you’ll probably have to pay for mortgage insurance.
Have a lender compare the impact of making a larger down payment to reduce or avoid mortgage insurance.
In addition, the sample calculation does not consider that you may have better uses for that money — for example, paying off high-interest credit card debt, making investments, or saving for future home improvements.
You may also want to use that money to invest in other assets than real estate for diversification, to boost a college tuition fund or to pad your retirement account.
The money you pay towards lowering your interest rate may not bring the same rewards as other investment vehicles, but if you plan to stay in your home for the long-term, a lower interest rate could be a smart move.
What Are Today’s Interest Rates?
Current mortgage rates depend in part on what you’re willing to pay for your home loan. In general, the more you pay, the lower your interest rate should be.
And remember, the lowest rate isn’t always the best deal. A good loan professional should be able to help you sort through your options and choose the lowest-cost program for your needs.Verify your new rate (Dec 8th, 2019)