Marino & Marino, P.C. Source: Leader BankIf you're preparing to buy a home, it will likely be the most expensive purchase you'll make in your life. Depending on the home buying and mortgage landscapes at the time when you're shopping for a home, you may be looking for a way to get a lower interest rate to help make your monthly mortgage payments more affordable.
One of the most common ways to get a more manageable interest rate in a high-rate environment is to work with your lender to buy points, also known as discount points, on your mortgage. Below we'll explore what mortgage points are, how they work, and whether buying mortgage points to lower your monthly payments makes sense for you. Let's dive in!
Mortgage Discount Points vs. Mortgage Origination Points
Before we get started outlining how to pay points to reduce your interest rate, let's take a minute to clarify the difference between the two types of "points" you may hear about during the home buying process. The first kind, mortgage origination points, refer to the origination fees you will pay to your lender for the cost of processing and reviewing your loan application -- Origination points don't lower your monthly mortgage payments. The second type of points, discount points, are paid at closing in order to obtain a lower interest rate and are what we'll focus on in the remainder of this article.
Basically, the two key differences between origination points and discount points are that origination points are not optional and do not help you achieve a lower interest rate at closing. For the sake of simplicity, where we refer to "points" below you can assume we are referring to discount points.
What Are Mortgage Discount Points and How Do They Work?
Discount points are prepaid interest on a mortgage loan, represented as a percent of your total loan, that helps you lower your interest rate. One point is equivalent to 1.00% of your total loan amount and reduces your mortgage interest rate by roughly 0.25%, helping make your monthly payments more manageable.
Discount points are usually paid during the loan closing process and are technically part of a buyer's closing costs. Criteria and guidelines for buying points vary by mortgage lender, but generally, lenders allow homebuyers to purchase from a fraction of a point up to several points depending on what the buyer can afford and what current mortgage interest rates look like. Discount points will be listed on both your loan estimate document which you'll get after applying for a loan as well as on your closing disclosure which you'll receive a few days before your closing.
Are Mortgage Discount Points Worth It When Buying a House?
Wondering whether to buy points to help get a lower monthly payment? A good first step to answer this question is to calculate your breakeven point or the timeframe that it takes to recoup the amount you spent up front on discount points. If you intend to own your home for a long time and specifically beyond your breakeven point, then buying discount points would be something to consider.
Your breakeven point can be determined by dividing the upfront cost of the points you purchased (for example, one mortgage discount point will require an up-front fee equal to one percent of your loan amount) by the amount you will save each month by lowering your interest rate (your monthly savings). For example, if you obtained a $100,000 30-year fixed-rate mortgage, you would divide the upfront cost of $1,000 by the reduction to your monthly payment of $15.17 as a result of your discounted interest rate to determine that your breakeven point is roughly 66 months or five-and-a-half years.*
Is Buying Mortgage Points Tax Deductible?
If you're planning on purchasing points on your home mortgage for a reduced interest rate, one of the first things you should do is consult a tax professional. Since mortgage interest may be tax-deductible if you itemize your deductions, you may be able to deduct the cost of the points you paid for since they are considered pre-paid interest. To determine whether this option is available to you, please consult with your accountant or other tax professional. In addition, the IRS has provided additional information on this topic here: IRS guidelines on buying points on a mortgage.
What Are Other Benefits of Paying Points on a Mortgage?
As mentioned above, the benefits of paying points on your mortgage depends on several factors, first and foremost the overall mortgage market and what the interest rate environment is at the time you're looking to buy. If you're purchasing a home in a high-rate environment, buying discount points is likely more enticing to you in order to lower your interest rate and make your monthly payments more manageable for the life of the loan. If interest rates are lower when you're looking to purchase a home, you may opt not to pay for the points to lower your interest rate so you can use that money as part of your down payment instead.
As mentioned above, if you plan to stay in the home for the longer term, you are more likely to save money in the longer term by buying points to reduce your interest rate. You can use the explanation above to calculate your breakeven point and determine how long you would have to stay in a home to save money by buying discount points.
Are There Other Ways Besides Paying Mortgage Points to Get a Lower Interest Rate?
Buying points is a great way to get a better interest rate and more manageable monthly payments, but if you're currently in the home purchase process and looking for alternatives, a mortgage buy down could be an option that works for you.
A buydown reduces the buyer’s interest rate and monthly payments for an initial period following the purchase of a home. This is typically achieved by the seller contributing funds to an escrow account that subsidizes the mortgage for an initial period, resulting in a lower monthly mortgage payment during this period for the buyer. In turn, the seller will usually increase the purchase price of the home to compensate for the costs of the buy down.
A buydown can be structured a few different ways, with most featuring discounted mortgage payments for an initial period with monthly payments subsequently increasing back to the fixed rate set in the note for the remainder of the loan. A 2-1 buydown allows the buyer to obtain a 30-year mortgage with a fixed rate where monthly principal and interest payments are discounted by 2% during the first year, 1% during the second year, and then revert to the initial, non-discounted rate for the remaining life of the loan.
Buying mortgage discount points is just one of the many ways we can help make your dream of homeownership a reality! Wondering which option is the best for you? Our team of experts, our network of recourses, and partnering banks and Loan Officers are ready to help. Contact us today!