So, you're buying a home and know you'll need a loan. But how are you going to pay for your home loan? Many borrowers will say that they just plan on paying their monthly mortgage until their mortgage term is up. This isn't always the best option. Yes, we said "option," because you do have options. To save you money and keep you in a safe financial situation, it is essential to understand the different options for paying your home loan. One of these options is through paying mortgage points.
What Are Mortage Points?
Points are a fee that borrowers pay upfront, they are paid during closing. A point's worth is 1% of the loan amount. In other words, a $200,000 mortgage would carry a $2,000 point value.
Discount points are a fee that is optional. It allows the borrower to, in essence, prepay the interest. Most lenders will allow borrowers to pay between one and four points--between 1% and 4% of the loan amount. For every point paid, the interest rate is usually lowered by about 0.25%. Sometimes this is referred to as 'buying down the rate'. By paying points, borrowers can lower their monthly payment for the lifetime of their loan. Sometimes, as incentive, a seller or home developer will agree to pay points.
For those home buyers who fell that paying a whole point is just to expensive for them to afford, fear not. Borrowers don't have to pay for a whole point. They can buy half a point or even a quarter of a point.
When Should You Use Points?
The obvious benefit of paying points is the reduced interest rate. If you plan to stay in your home for a while, this can save you a significant chunk of money. For example, if you have a 30-year mortgage for $200,000, a point will cost $2,000. If you do not pay any points, your interest rate will stay, for the example's sake, at 5.125% and your monthly payment will be roughly $1,088. If you pay one point or $2,000, your interest rate will drop to 4.875% and your monthly payment will drop by about $30. To make that initial $2,000 payment back, or break even, it will take about five and a half years. If you stay in your home for the duration of the 30-year mortgage, you will end up saving more than $9,000.
The more points you pay, the lower your interest rate, the lower your monthly payment and the more you will save on your mortgage. To gain the most out of buying points:
- Make sure that the interest rate deduction isn't significantly below 0.25%. This can differ based on the marketplace and the lender.
- Check and see how big of a tax-deduction paying points will get you. For purchasing a home, all of the points can be deducted in the year the mortgage was made.
- Make sure you can pay at least 20% of the home (if you choose to use money to pay points, and aren't able to afford the 20% down payment, you'll be forced to pay for private mortgage insurance, which could negate any savings from the lowered interest rate).
- Ensure that you have a fixed-rate mortgage. If not, at least make sure that you will break even before your initial fixed-rate period ends.
- Know that you will continue to own the home after you have broken even--this will likely be several years down the road.
The Consequences Of Points
Because you have to pay upfront for points, borrowers will have more expenses at the beginning of the loan process. And for refinancing and paying points, keep in mind that the borrowers equity position in their home will be reduced. Also understand that the tax-deduction has to be made over the life of the loan and can't be grouped into the first year.
When Should You Negotiate The Origination Fee?
Origination points can also sometimes be usefully flexible. In many situations, even when purchasing a home, the origination points can be negotiable. However, because a lender can't work for free, the borrower has to concede in another area. This will most likely manifest in the interest rate. If origination points are lowered, the interest rate will be raised so that the lender will eventually earn their commission from the yield spread premium. For borrowers who plan on refinancing or selling in the near future, this can be a very good deal. For everyone else, the higher interest fee will almost always amount to much more over the long-term than the origination points.
What You Should Consider When Deciding To Pay Points
There are three main considerations to think about when figuring out if paying discount points is the right decision. First, if you plan to stay in your home for the duration of the mortgage, paying points will save you significantly. If you plan on only staying for a few years, it's likely not worth it.
Second, if you have enough money to pay for the 20% downpayment and points--as well as planning on staying in the home for many years, again, paying points will save you money. If you have to choose between making the 20% cutoff for the downpayment or paying points and only paying 15% or 18%, don't pay points. The private mortgage insurance you will be forced to get will negate any savings the points would have made you.
Third, if you can very comfortably afford your mortgage payments, there is a strong argument for investing cash in other ways. Although it's never a sure bet, the stock market will very likely generate a higher return than the money saved through paying for points. However, if you feel unsure of your ability to make your monthly mortgage payments, points can be the safe and smart option.
A final tip to borrowers who are considering paying with points: Check the points in your loan estimate and closing disclosure to ensure that these documents reflect the correct interest rate.
Choosing whether to pay points takes a lot of consideration. It would be a wise decision to sit down with your lender, find out the facts, and see what makes the most sense for your situation. NewCastle is a full-service mortgage lender that would be happy to do just that. Contact us and we'll help you make the best decision for you and your finances.
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