When you’re financing a house, there are many terms and processes you might not be familiar with, especially if you’re a first-time buyer. Most buyers consider their interest rate the single most important aspect of their loan, so getting the best rate is critical.
Selecting the right lender with the right loan product for your needs plays a large part in your ability to get a great rate. In addition to that, a common practice buyers use to reduce their rate is the purchase of mortgage points, sometimes referred to as discount points.
In this post, we will cover what mortgage points are, how much they can save you, and how to decide if you should buy down your rate through mortgage points.
WHAT ARE MORTGAGE POINTS?
Mortgage points, sometimes called discount points, are fees that, in return, lower the interest rate of your loan. An industry phrase you may hear associated with this process is “buying down the rate” of your mortgage.
Generally, each point costs 1 percent of your mortgage amount. That would equate to $4,500 on a $450,000 loan. The reduction in your interest rate varies by lender, but the standard reduction is 0.25 percent per point. You’ll want to check with your lender for the specific amounts available to you on your loan. It’s also important to note that some lenders allow you to buy fractions of points, which can help with budget constraints.
HOW MUCH WILL MORTGAGE POINTS SAVE ME?
Mortgage points will reduce your monthly mortgage payment because they reduce your interest rate. Using our previous example of a $450,000 mortgage with an interest rate of 3.5%, and assuming 1 point costs 1 percent of your loan and reduces the rate by 0.25 percent, we can calculate the potential savings.
In this scenario, 1 point would cost you $4,500 and reduce your interest rate to 3.25%. Over the course of a 30-year mortgage, you would save $22,680 –paying for the $4,500 that the points cost you more than five times over.
But what if you’re not planning to stay in the home for the whole term? In that case, you’ll want to calculate the length of time you’d need to stay in the home in order to break even or begin to profit from your investment in points.
HOW TO CALCULATE YOUR BREAK-EVEN POINT
To recover the upfront fees you’ll pay for mortgage points, you’ll need to stay in the home long enough for your monthly mortgage payment savings to exceed what you paid for them. That’s why many buyers consider purchasing points when they are planning to stay in a house past the break-even point of their mortgage point discount.
There’s a simple formula you can use to help you determine this break-even point of buying down your rate. To calculate this, you’ll take the upfront cost of the points divided by the amount of monthly savings.
In our example, our upfront cost for 1 point was $4,500. That reduced our monthly payment from $2,021 to $1,958, which is a savings of $63 per month. If we plug in those numbers, we divide $4,500 by $63 resulting in a break-even time period of 72 months, rounding up.
In this scenario, we now know you would need to stay in the home for at least 6 years in order to break even on the purchase of your points.
HOW TO DECIDE IF YOU SHOULD BUY MORTGAGE POINTS
Most buyers base their decision to buy mortgage points on whether or not they will see a significant positive financial impact in the long run. If you plan to stay in your home longer than the break-even point, and you can afford to purchase the points while also leaving room in your budget for typical homeowner expenses, it can be a great cost-saving measure.
Like most financial decisions, you’ll have to carefully consider your personal finances, your budget, and your priorities. Buying a home is a very large purchase, and it’s also very personal. You’ll want to feel comfortable and confident in your decision, and that will come from being well-informed and having thoroughly reviewed your options.
When buying a home, you’ve typically got a lot more to consider than just mortgage points and interest rates. You’re looking for the best home to suit your family’s needs and often on fast-approaching deadlines. Our team of loan officers are the experts when it comes to home financing. Don’t hesitate to speak with them, as all First Heritage Mortgage loan officers will be happy to go over any aspects of the loan process with you.