If you are buying a home or refinancing, you have probably heard about “mortgage points.” This form of pre-paid interest can save you thousands of dollars over the course of your loan but in many circumstances is not worth the upfront cost. How do you know whether to pay points or not? Here’s a quick guide to help you figure it out.
Mortgage points – also known as discount points - are essentially a way to pay some of the interest upfront on your home loan. One point is equal to 1% of your mortgage amount. For example, one point on a $100,000 loan would be $1,000 or $2,000 on a $200,000. Mortgage points are paid directly to the lender in exchange for a lower interest rate. This is known as “buying down the interest rate.”
Paying mortgage points can reduce both your monthly payment and the amount of interest you pay over the entire course of the loan.
There is no standard scale for rate reductions and points. Each lender decides how much one point will reduce your interest rate and their fee schedule can change depending on the rate climate. For example, one lender might lower your interest rate by a quarter percent for 1 point, while another might give you the same discount for 1.125 points.
Paying points is all about saving money on your mortgage. Paying these upfront fees can make sense if:
If paying some points makes sense in your situation, you will need to figure out the “break even” period to know how many points to pay. This is calculated by dividing the total dollar amount of points you plan to pay by the monthly mortgage savings the lower interest rate generates. So say you pay one point equal to $2000 and that will save you $30 a month on your mortgage. Your break-even point would be roughly 67 months or five-and-a-half years. That means you would need to stay in that home at least 6 years to start seeing any true savings. No matter how much you pay, the longer you stay in your home the better for taking advantage of those savings.
Paying points is not a good idea if:
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