Mortgage points are a way to reduce the interest rate on your mortgage, but they’re not the right choice for everyone. This guide explains everything you need to know about mortgage points so you can make the right choice when financing your home.
What Are Mortgage Points, and How Do They Work?
When you take out a loan to buy a home, you may have the option of purchasing mortgage points. These so-called points, also known as interest points, are a way to lower your interest rate.
How Much Do Points Cost, and How Do They Save You Money?
A single point typically costs 1% of your loan amount. That means if you take out a $500,000 loan, one point would cost you $5,000.
So why would you decide to spend $5,000 on a “point”? What will it do for you?
Purchasing a point will lower your interest rate by 0.125%. That may not sound like much, but it can add up to significant savings over the life of your loan.
To see how this works, let’s say you took out a 30-year mortgage for $500,000 at a 4% interest rate. Over the life of your loan, you would pay $586,511 in interest.
If you purchased one point at closing, your interest rate would drop to 3.875%. That would lower your monthly payment to $2,149 and save you $21,511 in interest over the life of your loan.
Of course, this is a simplified example and your actual savings will depend on a number of factors, including the interest rate you’re currently paying, the amount of your loan, and how long you plan to stay in your home.
When Is It Worth It to Buy Points?
If you plan to stay in your home for a long time, it may be worth it to buy points. That’s because the longer you stay in your home, the more interest you will pay, so the more you stand to save by lowering your interest rate.
You should also consider how much cash you have available. If you’re able to pay for points upfront, you’ll save more money in the long run.
If you don’t have the cash to pay for points upfront, you may be able to finance them by adding them to your loan amount. However, this will increase the size of your loan and the amount of interest you’ll pay over time.
Before making a decision, it’s important to talk to a financial advisor or mortgage lender.
Are There Other Ways to Lower Your Interest Rate on a Mortgage (Aside From Paying for Points)?
There are a few other ways to lower your interest rate, but they typically come with trade-offs.
For example, you may be able to get a lower interest rate by making a larger down payment on your home. This will reduce the size of your loan, which is less risky for the lender. However, it also means you’ll have to come up with more money upfront.
You may also be able to get a lower interest rate by agreeing to a shorter loan term. A 15-year mortgage will typically have a lower interest rate than a 30-year mortgage, but your monthly payments will be higher.
Again, it’s important to talk to a financial advisor or mortgage lender to find out what option is best for you.
What Are the Risks of Buying Mortgage Points?
The biggest risk of buying points is that you may not stay in your home long enough to recoup the cost of the points. Remember, it takes many years to see significant savings from buying points.
If you’re planning to sell your home in the near future, it’s probably not worth it to buy points.
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