You probably already know that the interest rate you pay is among the most important factors contributing to the cost of your mortgage. The lower the interest rate you can get, the better for you and your finances. You may also know that points have something to do with the interest rate you end up getting with your mortgage. By buying points, you can lower your interest rate. So, when faced with the option to buy points, how do you know if it is a good idea? There is a little strategy involved in this decision.
Find out now: Should I buy points?
What Are Points?
Just to recap, points are fees that you can pay upfront when you buy a home to lower your interest rate on your mortgage. One point costs 1% of the loan value, so for a $240k loan, one point would cost you $2,400.
An Example of How Points Work
It can be a little complicated to evaluate points, but an example might help to clarify how this works: if you buy 1 point on a $240k mortgage, it would cost you $2,400. If the monthly savings of that point are $40, you need to plan on living in the home for at least 60 months for the purchase of the point to pay for itself (this comes from taking the total expense of the point $2400 and dividing it by the monthly savings, $40). You begin to save money on your mortgage after this point (no pun intended!).
When It Makes Sense to Buy Points
The answer to this question is time sensitive. Generally speaking, the longer you plan to live in the home you are purchasing, the more it makes sense to buy points. The longer you are in your home, the more of a chance you will have to make savings on a lower interest rate. Because points are fees you will pay upfront, you do need to make sure that you can afford this initial cost. It may add up to too much for you with other fees like closing costs and your down payment. In addition to these considerations, you also have to keep in mind the fact that points are generally tax deductible, so when you buy points it is almost like prepaying interest on your mortgage. To get serious with the decision to buy points or not, you should also take into account the opportunity cost of the money you would use to buy them. For example if instead of buying points, you had your $2400 in the bank for 5 years, you would have made some money on it. So, the actual point at which your points would pay for themselves is not $2400/40, but ends up being ($2400 (after tax) + expected value of future interest) / $40. Don’t reread that. That is why SmartAsset.com is here. We take all these factors into account and do all the number crunching for you so that you know you are making the right choice about points.
When Not to Buy Points
If you are only planning on living in a home for a short amount of time, maybe five years or less, buying points to lower your interest rate may not necessarily be to your advantage. In our example from above, this would mean living in your home for less than 60 months, or 5 years. If this is the case, you could probably find a variable rate mortgage with a very low initial interest rate that would cost you much less than a fixed rate mortgage even after buying points. For more reading on choosing between variable and fixed-rate mortgages, click here.
The Worst/Best Part About Points
Points can be confusing because while they are all worth 1% of your loan, between lenders, they don’t lower your interest by exactly the same amount. This makes things much harder for a borrower trying to find the best deal on the market. Lucky for you, part of what we do at SmartAsset.com is to calculate exactly what makes sense for you. We are able to make comparisons between mortgages with our free online optimization tool and point you to the mortgage that is ideal for your finances, points or no points. We built a tool that will crunch the numbers for you so that you know without having to do the math yourself that you are doing what is best for you. This sounds like it’s too good to be true, but it’s not!