Why pay points on a mortgage, and how do they benefit you? Points are a typically American arrangement, and refer to payments made in order to receive a lower interest rate. They have certain advantages, although these are not universal. Here are some details on mortgage points, and how they can be used to your advantage.
Some people get confused between their deposit and the subsequent points payment. The fundamental difference between the two is that the deposit is typically mandatory, while points are not, and tend to rise in 1% increments. Once you have agreed the loan details and paid the deposit, you might then be offered the opportunity to reduce the agreed interest rate by paying points on the mortgage.
For example, once your loan has been complete: you have paid the deposit and have agreed to a specific interest rate, whether fixed or variable, you may then be offered points. For each 1% of your mortgage loan you pay in cash, you will be offered a corresponding reduction in your interest rate.
What Do Points Cost?
In many cases, mortgage rates are quoted including points, the base rate not being quoted unless you refuse points. For example, if you are offered a mortgage of $200,000 at 7.5% and 2 points, you may have to pay 8% interest if you refuse to buy the points. If you pay extra points over and above what is offered, your interest rate will reduce accordingly. For example, if you borrowed $200,000, two points would be 2% of that, or a cash payment of $4,000 to get the 7.5% rate.
You have no obligation to pay points, and there are certain circumstances in which it would be wrong to do so. Keep in mind that your points agreement only last as long as the mortgage does, so if you change homes fairly quickly, or decide to refinance, your points agreement is terminated.
Should I Buy Points or Not?
You should pay points on a mortgage if you have a relatively low income, but a good lump sum to use to pay for the points. If you can afford more than a 20% deposit, you should use the extra to purchase points rather than reduce you principal sum borrowed.
Using the example above, on a $200,000 loan you will pay simple interest of $16,000 in a year at an 8% interest rate. You would pay $15,000 at 7.5% interest, saving $1,000 each year. Yes, interest reduces as your principal reduces, but not by much over the first few years.
By paying for 2 points at a total of $4,000, you would make that sum up after approximately 4 years and benefit thereafter, this is known as your break even point. If you paid that $4,000 as payment off the principal, you would save around 8% of that each year, or $320 – losing $680 every year in relation to points.
If you intend selling your house or moving on within 4 years, it does not make sense to buy points because you would spend more than you gained. Otherwise it does – in this example.
So Why Pay Points on a Mortgage?
The simple answer is to save money over the longer term. The longer the term of your mortgage, the more you gain by buying points. If you are short of cash when you purchase your home, but expect to earn more later, then points don’t make sense. But if you are cash-rich for a short while (an inheritance or medium lottery win), points can help you pay less for your home, or purchase a better home for what you can afford with your current income.
Pay the minimum of a deposit and the maximum points you can afford or are offered if you are keeping your home for a long time.
Still Have Questions About Points?
We can help. For a FREE consultation about point or any mortgage questions you might have, feel free to call us directly. We can help educate you on what loan programs are available and get you an up to the minute mortgage rate quote.