Buying a home is one of the most significant financial decisions you’ll ever make. Amid the whirlwind of down payments, closing costs, and loan terms, one option often raises questions: Should I buy mortgage points? These prepaid fees, also called discount points, can lower your interest rate in exchange for upfront costs. But are they worth it? Let’s break down what mortgage points are, how they work, and whether they align with your financial goals.
What Are Mortgage Points?
Mortgage points are essentially fees you pay to your lender at closing in exchange for a lower interest rate on your loan. Each point typically costs 1% of your loan amount and can reduce your rate by approximately 0.125% to 0.375%, depending on the lender and market conditions. For example, if you take out a $300,000 mortgage, one point would cost $3,000.
Paying points is optional, and many lenders allow you to purchase multiple points to achieve a more significant rate reduction. However, this upfront payment is non-refundable, so it’s essential to evaluate whether the long-term savings outweigh the initial expense.
The Pros and Cons of Buying Mortgage Points
Pros of Buying Points
1. Lower Monthly Payments
By reducing your interest rate, you’ll pay less each month. Over the life of a
30-year loan, this can result in thousands
of dollars in savings. For example, a 0.25% rate reduction on a
$300,000 loan can save $41,850 over 30 years.
2. Interest Savings Over Time
If you plan to stay in your home for more than a decade, the cumulative savings
from a lower rate may justify the upfront cost of points.
3. Tax Deductibility (if applicable)
Under the 2018 U.S. tax law, discount points are tax-deductible if your home is your primary residence. This
deduction can reduce your tax liability, making points an even more attractive
option for some taxpayers.
4. No Ongoing Costs
Once you’ve paid the points, you don’t have to worry about additional fees. The
lower rate and payments stay with you for the life of the loan.
Cons of Buying Points
1. Upfront Cost Burden
Paying $3,000 or more in one lump sum can strain your budget, especially if
you’re already stretched thin with closing costs (which can range from 2% to 5%
of the loan amount).
2. Opportunity Cost
The money spent on points could be invested elsewhere. If the return on your
investment exceeds the savings from the lower rate, buying points may not make
sense.
3. Short-Term Setback
If you plan to sell or refinance within a few years, the upfront cost of points
may not be recouped. The breakeven period (more on this later) is critical to
consider.
4. Not Always Worth It for Small Rate Gains
A 0.125% rate reduction might not be significant enough to justify the cost of
one point, especially if your loan term is short.
How to Decide: The Breakeven Analysis
The most important factor in deciding whether to buy points is how long you plan to stay in your home. Start by performing a breakeven analysis:
1. Calculate the Cost of Points
Multiply your loan amount by the cost per point (1%). For a $300,000 loan with
one point, this is $3,000.
2. Determine Your Monthly Savings
Use a mortgage calculator to compare your monthly payment with and without the
points. For example, a 0.25% reduction on a $300,000, 30-year loan could save
you about $91 per month.
3. Divide the Upfront Cost by Monthly
Savings
$3,000 ÷ $91 ≈ 33 months. This means you’ll break even in about 2.75 years. If you stay
in the home longer than this, the points pay for themselves. If not, you lose
money.
However, breakeven calculations assume you won’t sell, refinance, or pass away within the loan term. It’s also important to consider inflation, interest rate changes, and other variables.
Other Key Factors to Consider
1. Tax Implications
If you qualify for the tax deduction, factor it into your analysis. For
instance, if you’re in the 24% tax bracket, a $3,000 point payment could reduce
your tax liability by $720. Use this to offset the upfront cost.
2. Loan Type and Market Rates
- Fixed-rate mortgages are ideal for points, as the rate won’t change over time.
- Adjustable-rate mortgages (ARMs) may not benefit as much, since the initial fixed period is short.
- Conforming vs. jumbo loans: Jumbo loans (over conforming loan limits) may offer different point incentives.
3. Lender-Specific Offers
Rates and point discounts vary by lender. Shop around to compare offers and
determine which lender gives you the best breakeven point.
4. Alternatives to Buying Points
If the upfront cost is prohibitive, consider:
- A larger down payment to reduce your loan amount.
- A shorter loan term (e.g., 15 years) for faster equity buildup.
- Waiting for rates to drop before locking in a loan.
Real-World Example: To Pay or Not to Pay?
Imagine you’re taking out a $350,000 mortgage. Here’s a comparison:
|
Scenario |
Current Rate |
Monthly Payment |
Upfront Cost |
|
No Points Purchased |
6.5% |
$2,266 |
$0 |
|
One Point Purchased |
6.25% |
$2,177 |
$3,500 |
|
Two Points Purchased |
6.0% |
$2,079 |
$7,000 |
- Savings with one point: $2,266 – $2,177 = $89/month. Breakeven: $3,500 ÷ $89 ≈ 39 months.
- Savings with two points: $2,266 – $2,079 = $187/month. Breakeven: $7,000 ÷ $187 ≈ 37 months.
If you plan to stay in the home for 10+ years, buying two points could save $21,500 in interest. But if you move in 5 years, you’ll still be out $5,440 on the upfront cost.
Final Verdict: Is It Worth It for You?
Buying mortgage points can be a smart move if you:
- Plan to stay in your home for at least the breakeven period.
- Value stable, predictable payments over time.
- Qualify for the tax deduction.
However, it may not be ideal if you:
- Need to conserve cash for other expenses (e.g., renovations, emergencies).
- Expect to sell or refinance within a decade.
- Anticipate low returns on alternative investments (e.g., the stock market).
As with any financial decision, there’s no one-size-fits-all answer. Work with your lender or a financial advisor to model scenarios and determine whether buying points aligns with your goals. After all, every dollar you spend on points is a dollar that could be used to grow your wealth elsewhere.
By understanding the trade-offs and doing the math, you can confidently decide: Are mortgage points worth it for your new home?