A Beginners Guide to Mortgage Points: When Is It Smart to Pay?

Mortgage points, in short, are prepaid interest. At closing, you can choose to buy a point (depending on the lender), which costs 1% of the principal of your mortgage loan, and reduces your interest rate by about 0.25%.

Example: on a $100,000 loan with 6% interest, one point will cost $1,000 and reduce your interest rate to 5.75%.

Are they good to get?

It depends.

With the above example, buying a single point would reduce your minimum payment by roughly $12. Provided you only make payments at the minimum level, you would save about $148 a year. That means it would take about 7 years for you to break even on your investment.

What if you’re not going to stay in your home for that long? Simple: you lose money. It’s just not worth it for you. If, however, you have a 30-year loan and you plan on living in your home until it’s paid off, you have 23 remaining years to earn. For the best result, put that extra $12 per month into a savings account and watch it grow.

Plus, the IRS categorises mortgage points as prepaid interest, which makes them tax deductible in the year you signed the original loan. This could net you more savings, but don’t let it be the sole factor in getting one. This does not apply to refinancing loans; points on those are not tax deductible.

Another way to use them

Some lenders may even offer to give you points. It works in the exact opposite; 1% of your principal loan is applied as credit to your closing costs (meaning you don’t have to pay it) and your interest rate rises by 0.25%.

This can be beneficial in two ways; if you don’t plan on staying in your home very long, you will save money in the long run. Just make sure your budget allows for the higher monthly payment.

The other way comes into effect if you refinance. Because you have credit for it, it will cost less to refinance your loan. And, since borrowers can usually get up to 5 points, it’s possible to eliminate closing costs completely. Basically, you waive your closing costs in exchange for a higher interest rate.

It’s an investment.

In short, mortgage points can be an effective investment. But remember, like any investment, there is always a risk involved. Do you know what will happen 7 years in the future? No one does. You could be living in the same house, or you could be living hundreds of miles away. For some though, it can be worth the risk; analyze your financial situation and determine if mortgage points are right for you.

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