The Benefits of Mortgage Points and How They Work

If you’re in the market for a new or first-time home in Central Florida, you are already overwhelmed with decisions—different locations, mortgages, and navigating the closing process. Most of these decisions are made with the intent of getting the home that’s right for you at a price you can afford. One way to save yourself even more money on your home is to buy what are called “mortgage points.” Don’t understand what mortgage points are or how they work? This breakdown will help you decide if they are right for you.

What are Mortgage Points?

Mortgage points are essentially payments that a homebuyer makes to the lender to reduce their mortgage interest rate. This is also known as “buying down the rate” and saves you money on interest over the life of your mortgage. Typically, one mortgage point equals 1% of your loan amount and will lower your interest rate by 0.25%. This means that on a $100,000 mortgage, one mortgage point would cost $1,000. And you do not need to buy only 1 point. Many lenders offer fractional mortgage points that can help you fine-tune your desired rate and initial costs. Normally, fractional points are sold as ½ points that will lower your interest rate by 0.125% Capable of making a larger initial investment? You can also purchase multiple points to lower your interest rate by .5%, .75%, or even more. There are many mortgage point calculators available to help you determine your exact savings.

A calculator, coins, model house, and notepad and pen

Investing in permanent mortgage points lowers your interest rate for the entirety of the mortgage term, but there are temporary buydown options, as well. In these situations, a lump sum is paid up front for short-term interest reduction. This sum of money is then used to supplement payments in the initial years of the mortgage. As the money is spent, the interest rate returns to normal. This can be a great option for new homeowners who want to minimize the financial stress that accompanies the homebuying process.

Is it Worth it to Buy Mortgage Points?

Buying mortgage points allows homebuyers to save money on their monthly payments over the life of the loan. Especially for those who plan on living in the home long-term, mortgage points can save tens of thousands of dollars in interest. If you are operating with limited cash, planning to refinance in the future, or if you have a short-term plan, such as flipping the house, then mortgage points will likely cost more money than you would save. Additionally, if you have an adjustable-rate mortgage, the buydown will only benefit you during the initial, fixed-interest phase of the mortgage. Many lenders do not even offer mortgage points on adjustable-rate mortgages.

If you’re not sure whether you’ll save money, determine the “break-even” point—the time in the mortgage when you will have recouped the initial cost of the mortgage points. To do this, simply divide the cost of the points by the monthly difference in interest. For instance, you are saving $150/month in interest payments after spending $2000 on mortgage points, it will take you 14 months to earn your money back.

The Benefits of Purchasing Points for Your Mortgage

The benefits of mortgage points will vary from borrower to borrower, and depend on things such as credit score, loan type, and initial cash availability. For those who qualify, though, mortgage points can result in a reduction in your monthly payments—especially in the early life of the mortgage, when the interest-to-principal ratio is higher. This might be especially attractive to you if you plan on earning more money in the future.

Mortgage points will result in significant long-term savings if you plan on keeping your mortgage over the long-term. Again, if you plan to refinance or sell before the break-even point, then they may not be the right choice.

Mortgage points also come with tax benefits, as they are tax-deductible in the year that they are purchased. This helps to get some of that initial investment back. You will be limited to the amount you can deduct, however, if your mortgage exceeds $750,000.

How Much Can You Save with Mortgage Points?

How much you save overall depends on the mortgage principal, the number of mortgage points bought, and the lifespan of the loan. As each mortgage point buys you a 0.25% reduction in interest, a $350,000 loan at 7% interest that is lowered to 6.5% by purchasing 2 mortgage points will save you $40,000 in interest over thirty years. If you have greater access to cash, you can lower your interest rate more. Most lenders will cap you at 4 mortgage points, equating to a 1% interest rate reduction.

Other Factors to Consider When Purchasing Mortgage Points

When closing on your home, you are likely to pay what are called “origination points.” These are not the same as mortgage points. Origination points are paid to the lender to handle the cost of processing and handling the mortgage approval. Unlike mortgage points, these are not tax deductible, and their costs vary between lenders.

There are different ways to buy mortgage points: either paying upfront or rolling the costs into the mortgage. Paying up front is preferable, as increasing your mortgage will also increase the interest owed, possibly negating the benefits of buying the points. In either scenario, the points must be purchased ahead of—or at—the time of closing.

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Some homebuyers opt for a 2-1 buydown, where the interest rate and monthly mortgage payments are reduced for the first two years of the loan. To cover the lost interest in those first two years, lenders charge a fee. This fee is either paid by the buyer, though it can also be paid for by the seller in order to help market the property. Generally, a 2-1 buydown saves you two interest points in the first year, one interest point in the second, and then begin to pay full interest in the third year. This can be a solid money saving option so long as you are able to ultimately afford the full mortgage payments.

For those who plan on seeing your income increase in the coming years, a 2-1 buydown helps you keep pace with those early payments. However, if for some reason it doesn’t, you might find yourself struggling to make payments in that third year and beyond.

Kickstart Your Homebuying Journey with Showcase Properties

If you are looking to purchase a home in Central Florida or have questions about mortgages, the Florida housing market, or mortgage points, contact Showcase Properties and begin your homebuying journey today. Showcase Properties can help you find the perfect home in Central Florida, from Ocala to Gainesville to Citrus County, If you would like more homebuying tips, real estate information, and local listings, be sure to subscribe to our blog to stay informed and make the best homebuying decisions!