Mortgages are stressful. They are, by far, the largest loan most consumers ever acquire, and there are a lot of terms thrown around in the midst of trying to make a big decision as to which mortgage to use.
One of those terms is “mortgage points” or “loan points.” Some lenders will also use the term “discount points.” We’ll refer to these as Points, with a capital P, going forward.
Broadly speaking, Points are fees that you, the borrower, pay directly to a lender when your loan closes in order to enjoy a lower interest rate. Frequently this is called “buying down the rate” because, in essence, that is exactly what you’re doing. You are paying a lender interest in advance in exchange for a lower interest rate for the life of your loan.
How much does a Point cost?
A Point is 1% of the loan amount you will be borrowing. In exchange for that cash upfront, the mortgage originator will reduce the interest rate on your mortgage by 25 basis points, or 0.25%.
Let’s say you’re buying a $500,000 home and putting down $100,000. Your mortgage will have $400,000 in principal balance and an interest rate of 4.0% fixed for 30 years.
A Point on this loan would cost 1% of the $400,000 amount borrowed, or $4,000. In exchange, the lender will reduce what would have been a 4.0% interest rate to 3.75%. If you paid two Points up front, you could reduce the interest rate even further to 3.5%.
Is this a trade worth making? Is it worth $4,000 or $8,000 to reduce the interest rate 0.25% or 0.5%, respectively?
Should I buy loan Points?
Well, it’s complicated. It depends on the individual.
Only if you seriously think you will be in the home you are buying for the better part of a decade should you consider buying down your rate. If this is a home you are going to be in for only a few years, Eggworth does not recommend paying for any mortgage Points whatsoever. Instead, shop for the best rate you can find and be happy with it.
If, however, you think you will be in the home you are buying for many years, there is a more detailed exploration of loan Points that bears consideration.
Using the above example of a $500,000 home purchase and a $400,000 mortgage at 4.0% fixed for 30 years, take a look at how your loan would be affected by buying down points:
|Loan amount: $400,000||No Points||1 Point||2 Points|
|Cost for Point(s)||$0||$4,000||$8,000|
|Monthly Payment Savings||N/A||$57.20||$113.48|
|Breakeven time||N/A||70 months||70 months|
|Total payment savings over 30-year loan||N/A||$20,592||$40,852.80|
Note that this analysis is ignoring the costs of insurance and property taxes, which will increase the total monthly payment.
While the “total payment savings” line is eye-poppingly large, don’t let the allure of that large savings number sway you into buying Points without further due-diligence. Remember, in order to save those amounts of money, you must pay $4,000 or $8,000 for one or two Points, respectively, at the time of origination for your mortgage.
What if, instead of buying those Points, you invested that cash into an S&P Index fund, for instance? According to CNBC, the average annualized total return for the S&P 500 index over the past 90 years is 9.8 percent. If you plunked $4,000 into an S&P index fund and those historical returns stayed the same, you’d be looking at a cool $66,089 in thirty years. Or if you put $8,000 into that same fund, you’d be looking at $132,178!
Here at Eggworth, we encourage you to really think about two major considerations when shopping for a mortgage. First, how long are you going to stay in the home you are buying? If you plan on staying in the home only five years, don’t buy any Points. If you’re committed to living in that home for ten, twenty, or thirty years, Points may be worth considering, but so too may be investing that cash you’d spend on Points.
Why do mortgage Points matter?
Points are often pitched as a great thing for you, as a borrower, to buy. A lower rate! Isn’t that great!?
But the reality is that the average American owns their home for about 8 years. Thus, while the average homebuyer may benefit ever so slightly from buying Points when they originate their mortgage, the benefit is quite small comparatively. Further, the financial benefits of investing the money that would have otherwise been spent on Points will likely outweigh the slight savings in monthly mortgage payments.
For many homebuyers, buying down a rate results in a large transference of money from your pocket to your lender’s, without much benefit to show for it. Buyers be warned!
While buying Points reduces your interest rate, it does not have the same effect on your APR. Read more about understanding what an APR is to truly begin mastering the ins and outs of mortgages!