In the world of mortgages, points can serve as a way for a homebuyer to trim the interest rate on their loan. Buying discount points, or mortgage points, can be helpful if a buyer intends to hold the home for a long time or if they have enough of a down payment and additional amounts to lower the interest rate.
If they are using points, they should expect to hold onto the loan for an extended period of time that would allow them to break even. It could take a long time When it comes to points in a mortgage, there’s one general rule of thumb: the longer the loan, the more you can save by using points in your mortgage.
Points could also affect how long it takes for you to get a mortgage. Although this is rare since points have become so ubiquitous these days, it’s definitely worth considering. Depending on the specifics of your situation, it’s yet another detail that must be worked out with your loan officer.
If you’re wondering if points are right for you, we encourage you to first learn how they work, if they’re worth it, and other important information that can help you make the right decision for your situation. Below, we’ll explain some of the most important factors that can impact your decision, so you know what to expect when it’s time to close on your loan.
What are mortgage points and how do they work?
Understanding how mortgages work is a complicated task, especially when you throw in the concept of discount points! These points come in two different forms. The first type of points is discount points. The second is rebate points. Each of these options gives you benefits that help you with your mortgage and impact your interest rate over time. Here’s what to expect with each type of mortgage point:
- Discount points, or also known as mortgage points or just points, allow the homebuyer to lower the interest rate of their loan, which in turn, lowers the amount they pay each month. The homebuyer here is essentially buying down their interest rate, which is perfect for long-term loans. When the points are paid to handle the loan origination fees, these are called origination points, and they are not used to pay down the mortgage interest rate.
- Rebate points, or negative points or reverse points, are rebates paid by the lender (i.e., the bank) to the borrower (i.e., the homebuyer) to cover the closing costs for their purchase. This allows the buyer to have a no-closing cost mortgage. These types of points do not affect the buyer’s interest rate because they essentially combine the closing costs onto the mortgage loan amount.
Discount points can typically lower a rate by 0.25 percent. For instance, if you’re approved for a mortgage loan at a rate of 4 percent, and you buy 2 discount points upon closing, you may have an interest rate of 3.5 percent for the duration of your loan.
Are mortgage points worth it?
Determining if mortgage points are worth it means looking at your specific situation. Various factors come into play when considering points, not just the cost. Of course, you have to consider what type of points you need and whether you’re willing to make an initial investment in the points or if you need negative points and can afford a higher monthly payment. You must also keep in mind that a point on your mortgage is roughly 1% of the total loan amount. Here’s how it works:
- If you want to purchase a home with a $250,000 mortgage, a point would cost $2,500.
- If you wanted to buy 2 discount points, you would pay an additional $5,000 on top of our closing costs to lower your interest rate.
Buying discount points is essentially prepaying your mortgage interest, while also lowering your mortgage by a small percentage. It can be worth it for a lot of buyers, especially if you have a lot of money to cover the down payment, closing costs, and additional amount to purchase the points. If you cannot afford the closing costs on your mortgage loan, it may be worth it to you to look into rebate points.
Are you planning to refinance anytime soon?
Points also apply for home refinances too — depending on how soon you plan to refinance your mortgage after moving in will be a factor that helps determine if you should buy points. For example, if you move in and refinance within the first year, it may make sense to not purchase points. Why? Because a refinance usually means you are getting a brand new loan so if you are ditching the old loan for a new one, then all those points you paid for have essentially gone to waste. Depending on how many times you plan to refinance — or how soon you plan to refi after moving in — is worth discussing with your loan officer.
Are mortgage points tax deductible?
Certain acts over the last few years have put a cap on what is tax-deductible. However, when you buy discount points, you are essentially prepaying interest, which means you may be able to claim the prepaid interest as a tax deduction. However, when you buy discount points, you are essentially prepaying interest, which means you may be able to make them tax-deductible. There is one thing you can do to determine how much you may be able to deduct when it comes to your mortgage points. First, ask your potential lenders to provide you with two different estimates: one that shows your estimated closing costs if you buy points and one that shows the estimated costs if you don’t buy points. Second, provide these estimates to whoever does your taxes.
Origination points, as discussed above, are paid to lenders early in the process to extend the loan and are not related to discount points. They are not tax-deductible. These points are for the purpose of originating, reviewing, and processing the mortgage, so they are not paying the mortgage interest.
Are points right for you?
Before you make the decision to purchase points, you have to keep in mind your current situation and where you want to be long term. First, do you intend on staying in your home for a long period of time without selling it? Second, do you have the initial upfront costs to afford points along with closing costs and your down payment? Third, how complicated is your financial situation? (For example, mortgages for entrepreneurs and small business owners are more complex than standard W2 employees and thus require more attention). In a perfect world, you would be able to have a low interest rate on your mortgage and a manageable monthly payment, but you may not have the resources to put down a significant amount of money before entering into your loan.
No matter your decision, it’s always best to consider the pros and cons of points. Know what points you are buying and how they impact your loan now and in the future. The more you know about your loan and the factors that go along with it, the more you can make an informed decision that works for you over the long term. Speak with your lender about your options, a tax consultant to know how points impact your tax deductions, and more. This information can help you make the right decision for your situation, giving you peace of mind over the life of your loan and putting you in the most favorable position possible.