There’s a lot to think about when buying a home, applying for a mortgage, and securing a loan.
And there are some things that you might not even consider, as a first-time homebuyer—such as mortgage points.
While overlooked by some, it’s critical to consider the pros and cons of paying for mortgage points.
Let’s dive into what mortgage points are, how they work and if they’re worth it, and how you can take the next step toward buying your home.
What are mortgage points?
In simple terms, mortgage points are a form of prepaid interest.
This allows you to pay upfront for a lower interest rate and monthly payment. Many people refer to it as “buying down” an interest rate.
One point equals one percent of your total loan amount. For example, if you’re borrowing $300,000, one point would cost $3,000. Or if you’re borrowing $500,000, one point would cost $5,000.
How does it work when you buy mortgage points?
In most cases, you’ll pay for mortgage points along with closing costs.
For each point that you purchase, your APR is reduced along with your monthly payment. So, the more points you buy the lower your rate. And the lower your rate, the lower your monthly payment.
It’s the most common to buy points on a fixed-rate mortgage. With an adjustable-rate mortgage, your interest rate is only fixed for a short period of time (five years, for example). So, paying for points doesn’t make nearly as much sense.
Tip: It’s best to pay for mortgage points if you have plans to stay in your home for a long time. Your goal is to reach the break-even point, which is when the interest you’ve saved is more than the amount you paid for points.
What are origination points?
It’s a misconception that origination points and discount points are the same.
Origination points are fees paid to a lender to originate, review and process your loan. This is different from discount points since they do not directly reduce the interest rate.
Is it worth it for me to pay points?
This is the million-dollar question. You don’t want to buy mortgage points if it won’t save you money over the long run.
The best way to answer this question is to calculate your break-even point. Do this by dividing the cost of the mortgage points by the amount the reduced interest rate will save you each month.
$3,000/$42 = 71 months
So, if you stay in your home for six years, you’ll pass the break-even point. You’ve reached the point when all future savings is “money in your pocket.”
Tip: Use a traditional mortgage calculator and/or a mortgage points calculator to understand the impact of buying points. As you crunch the numbers, remember to do the same with your break-even point.
What are my next home-buying steps?
At this point, you understand the basics of mortgage points and how to calculate if you should pay them. Now, it’s time to use this knowledge to your advantage when buying a house.
So what should you do next?
1. Receive a preapproval
This is the first step for almost every homebuyer. You need to know how much you can borrow, as it’ll guide your search. Without pre-approval, you could find yourself shopping for homes that you can’t afford.
2. Determine how much money you need to borrow
Once you know how much you can borrow, you must decide how much you need to borrow. This is based primarily on two factors: the price of the home and the amount of your down payment.
For instance, if you’re buying a $300,000 home and have a $100,000 down payment, you only need to borrow $200,000. This will directly impact the cost of mortgage points (among other expenses).
3. Ask your lender about mortgage points
While the process of buying mortgage points is generally the same from lender to lender, you still want to ask about this. Focus on details such as when you have to make a decision, how much points cost, and how many you can purchase.
4. Decide on a mortgage type
Before you can finalize your decision to buy points, you must first decide on a mortgage type. As noted above, it’s most common to buy points on a fixed-rate mortgage. So, if buying points are on your radar, you want to strongly consider a fixed-rate conventional purchase.
5. Calculate how many points to purchase
The final step is deciding how many points to purchase. The more points you purchase, the more money you’ll pay out of pocket at closing. However, more points also result in a lower interest rate and monthly payment.
Frequently asked questions
Here’s a short list of frequently asked questions associated with mortgage points.
How much does your lender charge for mortgage points?
One discount point costs one percent of your home loan amount. So, if you’re borrowing $100,000, one discount point will cost $1,000.
How many mortgage points can you purchase?
While there’s no set limit, the majority of lenders don’t let you purchase more than four points. Ask this question of any lender you’re thinking of borrowing from.
How many mortgage points can you afford?
This depends on many factors, such as the cost of the home, closing costs, and your personal financial circumstances.
How long do you plan on staying in your home?
If you have any reason to believe you may not stay in your home over the long run, consider if buying mortgage points is a good idea. This is where calculating the break-even point is so important.
You can answer these questions on your own, while also leaning on your lender for information and guidance. The one thing you want to avoid is ignoring these questions, among others, and hoping for the best. Knowledge is power when buying a home.
Buying a home is a big decision that will impact both your personal and financial lives.
You want to do everything just right, and part of that is deciding if you should buy mortgage points. If you’re ready to take the first step, contact AAA Banking to discuss your home-buying needs.
From mortgage types to mortgage points to using HomeScout to find your dream home—we’re here to remove the stress from the home-buying process.
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