If you find mortgages confusing, you're not alone. There are a lot of numbers to compare -- loan terms, interest rates, down payments, closing costs, and more. And then there are mortgage points. Not every mortgage offers them, and they can either help or hurt you depending on how long you plan to stay in the home and how much you can afford for a down payment.
Here's a brief overview of how mortgage points work and when it may and may not be a good idea to pay them.
Origination points versus discount points
Mortgage points come in two different types: origination points and discount points. Both types are equivalent to 1% of your mortgage amount. So if you have a $100,000 mortgage, one point is worth $1,000.
A lender may ask you to pay one or more origination points to cover its own costs for processing the loan. Not all mortgage lenders will charge these, and if yours does, you may be able to negotiate with them to get these points removed. This can save you money on your closing costs.
The more common type of mortgage point is known as a discount point. This is essentially prepaid interest. Your mortgage may have zero, one, or several discount points. You can pay the equivalent dollar amount with your closing costs, or your lender may enable you to roll them into your mortgage. This means the cost of these points will be added to your mortgage balance, so you'll pay less upfront, but you'll have to borrow a few thousand dollars more. In exchange for paying points, your lender will lower your interest rate. The exact amount it will lower your interest rate can fluctuate, but in most cases, one point is worth a quarter of a percentage point off your interest rate.
Discount points are usually tax-deductible as mortgage interest, provided the mortgage is on your primary home or a secondary home that you're renting out and you itemize your deductions. Origination points are usually only deductible on rental properties. Before you agree to pay points, it's always a good idea to check with a tax professional to ensure that you will be able to deduct your points come tax time.
Should you pay discount points?
Paying points on your mortgage can be a good idea, but only in certain circumstances. As a general rule, it makes more sense if you plan to be in your home for a long time than if you plan to move within a few years.
Say you get a 30-year fixed-rate mortgage for $250,000 with a 4.5% interest rate. Your monthly payments would be $1,267, and you'd end up paying $456,000 over the lifetime of the loan. Now, take that same loan and say you paid two mortgage points. That would be $5,000. In exchange, your interest rate would be lowered by half a percent. Now your monthly payments would only $1,194, and you'd only pay $430,000 over the 30-year period.
If you're in your home for the full 30 years, a savings of $26,000 might well seem worth that extra $5,000 you paid in points at closing. But the same can't be said if you were only to stay in your house for a couple of years. It would take you almost five years and nine months to recoup that $5,000 you spent on your mortgage points. In that case, it's probably not worth it.
You also have to think about whether you can afford to pay points at closing. If you're struggling to come up with a down payment, this may not be an option for you. Your lender may allow you to roll these costs into your mortgage, but then you're borrowing a larger sum, and your monthly payments will be higher.
It all comes down to the math. Get some estimates from your lender as to how much the points would lower your interest rate. Then set aside some time to run the numbers and see how long it will take you to break even and how much it'll save you over the lifetime of the loan. Weigh this against how long you plan to be in the home and how much money you can afford to put down at closing to decide whether paying points is the right move for you.
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