Paying discount points to get a lower interest rate can be a great strategy. Lowering your rate by even 25 basis points (0.25%) could save you tens of thousands over the life of the loan. But there’s a catch. You have to keep your mortgage long enough for the monthly savings to cancel out the cost of buying points. Before buying points, you’ll need to understand the implications, so let’s break it down.
What Are Mortgage Points?
Mortgage points represent a percentage of your loan amount (purchasing one point costs 1% of the loan amount). Mortgage points are an additional upfront cost when you close on your loan, but they’re also a way for borrowers to negotiate a lower interest rate on their mortgage. For example, by paying 1% of the loan amount up front, borrowers can typically unlock mortgage rates that are about 0.25% lower.
It’s important to understand that buying points does not mean you’re making a larger down payment. Instead, borrowers “buy” points from a lender for the right to a lower rate for the life of their loan. Buying points does not help you build equity in a property — you just save money on interest. Don’t forget, this is on top of closing costs and down payment.
The break-even point is when you’ve paid off the cost of buying the points. From then on, you’ll enjoy the savings from your lower interest rate.
For example: On a $300,000 loan with a 7% interest rate, purchasing one point brings the mortgage rate to 6.75%, dropping the monthly payment from $1,996 to $1,946 — a monthly savings of $50. The cost: $3,000. The break-even point: $3,000/$50 = 60 months (5 years).
So is buying points worth it? The answer starts with determining how long you plan to stay in the home and when you'll hit the break-even point.
Respect your budget
First off, don’t buy mortgage points if you can’t afford it. If paying for points would leave you short on cash for necessities, or cut into your emergency fund, skip it. Don’t lose sight of your budget and get fixated on the lowest possible rate, putting your financial health at risk.
Alternatives to Consider
What would you do with that money if you didn’t buy points?
- If you have high-interest credit card debt or other high interest loans, put extra money toward paying off your consumer debt before you buy points to lower your mortgage interest rate.
- If your 401(k) comes with employer matching and you’re not already contributing the maximum match-able amount, don’t buy points. Put that extra money into your 401(k) and take advantage of the match.
- Open a savings account to start putting away emergency funds for possible future home repairs or car repair expenses.
Take the long view
Buying points will lower your monthly mortgage payments up front, but it will take a while to hit the break-even point and realize the savings benefit.
If you think you will move and sell the property before the break-even point, you might want to skip buying the points. The longer you stay in your home past the break-even point, the more you will reap the benefits. If you think the house you’re buying is your “forever home,” go ahead and buy points.
It is hard to know exactly how long you’ll stay in a home, so ask yourself these questions:
- How much do you like the house?
- Is it the right size for your family? Will you be expanding your family soon or becoming an empty nester?
- How likely is it that you will move to a different city to find a new job?
- Will the house need expensive repairs and maintenance?
- Do the local schools meet your family’s needs?
- How long is the commute to your workplace?
If this is a “starter home” then buying mortgage points might not be the best use of your money.
Consider your long-term plans and weigh the decision to buy points against other ways to spend your money. If you follow the tips above, you’ll make an informed decision you can feel good about. If only choosing your dream home were that easy!
Your local Country Living mortgage specialist is happy to talk through these decision points. Reach out for more information and guidance on whether buying points is right for you.