You may be familiar with the idea of “buying down” your mortgage. This practice involves buying mortgage points, also known as discount points, or paying upfront fees to lower your mortgage’s interest rate in the long term.
For some people, buying mortgage points can make a lot of sense and save them money in the future, but for others, it might not be as sound a strategy.
This article will examine the basics of mortgage points and different reasons why buying points may or may not benefit some homebuyers. That way, you can decide whether it’s right for you.
Understanding mortgage points
When you go to close on your new home loan, your lender may allow you to buy mortgage points. Mortgage points are an expense you pay alongside closing costs that allow you to reduce your home loan’s interest rate and monthly payment.
Lender policies vary, but often, for around 1% of the total loan amount, you may be able to purchase a single mortgage point. One mortgage point may lower your mortgage’s interest rate by around .25%.
If you’re interested in buying mortgage points for your home, you may want to ask your lender what their specific policy is and shop for lenders that give you the most value on mortgage points.
Buying down a mortgage: An example
Let’s look at an example of how buying down a mortgage could save you money in the long run.
Suppose you buy a home worth $400,000 and make a down payment of 20%, or $80,000, meaning your mortgage is worth $320,000. In this scenario, you are offered an interest rate of 6.5%, and you have a 30-year fixed-rate mortgage. Each month, at that interest rate, you’ll make a payment on your loan of around $2,020 (excluding property taxes and additional fees). By the end of your mortgage term, you may have paid upwards of $408,000 in interest.
Let’s say you buy a mortgage point upfront to lower your interest rate from 6.5% to 6.25%. Since your mortgage is worth $320,000, your point costs you 1% of that, or $3,200. With your lowered interest rate, your new monthly payment is around $1,970, and the interest you’ll pay on the loan now is around $390,000 after 30 years.
While you’ll only save a small monthly amount after buying the point, over time that point could save you significant amounts of money.
When buying down your mortgage makes sense
Buying down your mortgage makes sense for homeowners who plan to stay in their home until they’ve broken even on the point they purchased. This is known as the “break-even” point.
For example, if you spent $3,200 on a point for your mortgage and save $100 per month on your mortgage payment, you’ll break even after 32 months. You can then start reaping savings from your initial investment.
When buying down your mortgage may not make sense
You might not want to buy down your mortgage for a few reasons. If you plan to sell or refinance your mortgage before you reach your break-even point, it likely won’t benefit you to make the investment.
You might already have been offered an appealing rate, so you might not save much after buying points. Maybe you have a tighter budget at closing but anticipate more funds in the future. In this case, you might not want to spend more in the short-term even though you’ll have more in the long-term.
Alternatives to consider
While buying points is a good option for some borrowers, you might consider a few other options. One alternative could be making a larger down payment on your home. A larger down payment could reduce your loan balance, allow you to pay a better interest rate, or even eliminate mortgage insurance in some cases. Or, perhaps you want to use your funds to pay off other outstanding debts instead of purchasing discount points on your mortgage. Mortgage interest rates are generally lower than other high-interest forms of debt, so you might prefer to pay off other types of debt before you buy mortgage points.
Making a financial plan that works for you
Everyone has different financial needs and priorities, so not everyone will benefit from buying mortgage points. If you think you’ll only stay in your home for a few years and leave before you reap the benefits of mortgage points, they might not be right for you. If you plan on staying for a long time and want to lower your interest rate, you could benefit from buying points.
Consider your current assets and how much you want to spend on up-front costs. Balance them with the longer-term repercussions to see which path works better for you.
Disclaimer: Article content is intended for information only. It may not reflect the publisher nor employees’ views. Consult a mortgage professional before making financial decisions. Publishers or platforms may be compensated for access to third party websites.
