When you get a mortgage, you have the option to purchase points in order to get a lower interest rate. But what does that mean? This guide explains everything you need to know about purchasing points, including what they are and how they can help you save money on your mortgage.
What Does it Mean to Purchase Discount Points to Get a Lower Interest Rate?
This guide explains:
- What are points and what do they do?
- How do you purchase points and how much does it cost?
- What are the benefits of purchasing points for a lower interest rate on your mortgage loan ?
- How can you decide if purchasing points is the right decision for you ?
- What are the risks associated with purchasing points ?
- How to calculate whether or not purchasing points makes financial sense for you
- When should you consider buying points in order to get a lower interest rate on your mortgage loan?
Scroll down for a closer look at each.
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What Are Points, and What Do They Do?
When you get a mortgage, you have the option to purchase points. But what are points? Points are a type of fee that you pay in order to get a lower interest rate on your loan. Each point costs 1percent of your mortgage loan amount. If you’re taking out a $200,000 mortgage loan, one point would cost you $2,000.
You’re not required to purchase points, but if you do choose to purchase them, it will lower your interest rate. A lower interest rate means that you’ll have a lower monthly payment, and you’ll save money on interest over the life of your loan.
Related: 3 secrets for home-buying success in today’s red-hot market
How Do You Purchase Points, and How Much Does It Cost?
When you’re ready to purchase points, you’ll need to talk to your lender. Your lender will give you an estimate of the fees you’ll pay at closing. This estimate will include the cost of points, as well as any other fees associated with your loan.
The cost of points varies, but each point typically costs 1 percent of your mortgage loan amount. So, if you’re taking out a $200,000 mortgage loan, one point would cost you $2,000.
What Are the Benefits of Purchasing Points for a Lower Interest Rate on Your Mortgage Loan?
There are several benefits of purchasing points:
- A lower interest rate means that you’ll have a lower monthly payment.
- You’ll save money on interest over the life of your loan.
- If you plan on selling your home before you’ve paid off your mortgage, you may be able to sell for more than you owe on your loan.
- You can deduct the cost of points on your taxes if you itemize deductions.
- You may be able to negotiate with the seller to pay for all or part of the points.
How Can You Decide If Purchasing Points Is the Right Decision for You?
If you’re considering purchasing points, there are a few things you should keep in mind:
- How long do you plan on staying in your home? If you plan on selling your home before you’ve paid off your mortgage, you may not benefit from purchasing points.
- How much can you afford to pay upfront? Points are paid at closing, so you’ll need to have the cash available to pay for them.
- What’s your financial goal? If your goal is to save money on interest, purchasing points may be a good idea. But if you’re trying to lower your monthly payment, there may be other options that make more sense for you.
- What’s the current interest rate? The higher the interest rate, the more benefit you’ll get from purchasing points.
- Are points tax deductible? If you itemize deductions on your taxes, you can deduct the cost of points.
Related: What’s the difference between a home inspection and a home appraisal?
What Are the Risks Associated With Purchasing Points?
There are a few risks to keep in mind when you’re considering purchasing points:
- You may not stay in your home long enough to benefit from the lower interest rate.
- You may not qualify for a mortgage if you don’t have enough cash to cover the cost of points.
- The tax deduction for points may be less than the actual cost of the points.
- You could end up paying more interest if you refinance or sell your home before you’ve paid off your mortgage.
How to Calculate Whether or Not Purchasing Points Makes Financial Sense for You
If you’re thinking about purchasing points, you’ll want to calculate whether or not it makes financial sense for you. To do this, you’ll need to compare the interest rate with and without points.
You can use this formula to calculate the break-even point:
Break-even point = cost of points / (interest rate without points – interest rate with points)
For example, let’s say that you’re taking out a $200,000 mortgage loan at 4 percent interest with no points. If you purchase one point, your interest rate will drop to 3.5 percent. The cost of the point is $2,000.
To calculate the break-even point, you would divide the cost of the point ($2,000) by the difference in interest rates (0.5 percent). This gives you a break-even point of 400 months, or 33.3 years. This means that it would take 33.3 years for you to save enough money on your monthly payment to make up for the cost of purchasing the point.
When Should You Consider Buying Points in Order to Get a Lower Interest Rate on Your Mortgage Loan?
You should consider buying points when:
- You’re planning on staying in your home for a long time. The longer you stay in your home, the more benefit you’ll get from a lower interest rate.
- You can afford to pay for points at closing.
- You’re trying to lower your monthly payment.
- You qualify for a mortgage with a higher interest rate and you want to lower it.
- The interest rate without points is much higher than the rate with points.
- You itemize deductions on your taxes and you want to take advantage of the tax deduction for points.
- You’re trying to negotiate with the seller to pay for all or part of the points.
Purchasing points is a personal decision and there’s no right or wrong answer. You’ll need to weigh the pros and cons and decide if it makes sense for you.
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