Mortgage rates are a major factor in affordability. While some US markets have stalled, our region is still largely in a seller’s market. Getting the most out of your budget can feel like an uphill battle, especially when you add higher borrowing costs to the mix. But there is a way to secure a lower rate through mortgage points. Also known as discount points, this strategy allows buyers to pay an upfront fee in exchange for a reduced interest rate over the life of their loan. Let’s break down how mortgage points work and whether they could help you save in the long run.
THE BASICS
One mortgage point costs 1% of your loan amount. The interest rate reduction varies by lender, loan type, and market conditions. Typically one mortgage point lowers the rate by about 0.25%. So let’s say your loan amount is $200,000 and you’re locked in at a rate of 7.35%. You decide to buy two mortgage points for $4,000 total and this lowers your rate to 6.85%.
DETERMINING THE BREAK-EVEN POINT
To figure out how long it will take to recoup that $4,000, we need to calculate the principal and interest payments for both rates. A $200,000 loan with 7.35% interest would be $1,378 per month in principal and interest. At 6.85%, the principal and interest payment would be $1,311. Therefore, buying points saves you $67/month and it would take 60 months (5 years) to break even. On a 30-year mortgage, this would save you $24,273 in interest over the life of the loan.
THE TRADE-OFFS
As you can see, this is a longterm strategy because you would lose money if you ended up selling before 5 years. It can also be a difficult call in a high rate environment because you would lose money if rates dropped and you refinanced before 5 years. If you don’t intend to stay in the home that long, you should forgo buying points or run calculations on the break-even point if you were to spend less on a buy-down.
OTHER CONSIDERATIONS
What if you need to bring your monthly payment down but you don’t think you’d hit the break-even point for mortgage points? First, talk to your lender to see the impact of a higher down payment. Let’s stick with our numbers that we used before. You’re getting a 7.35% rate but this time the purchase price is $200,000 with $6,000 (3%) down. The principal, interest, and estimated PMI would be around $1,523/month. (Note: the average cost of PMI ranges from 0.46% to 1.5% of the annual loan amount depending on your credit score and loan terms.) Instead of paying $4,000 toward mortgage points, you could bump your down payment to $10,000. Having a 95% LTV and lower PMI could save you in the ballpark of $100/month.
Another option is negotiating concessions with the seller and using that toward discount points. Using this negotiating power to save elsewhere might be best if you won’t reach the break-even point, but if you expect to stay there longterm or don’t know how long you’ll live in the home, at least you’re lowering your payment without increasing your cash to close.
Discount points don’t make sense in every situation but it’s worth discussing with your loan officer, especially if elevated rates have you hesitant to buy. It doesn’t hurt to have another tool in your tool belt that can make homeownership more affordable.
Need a trusted lender to help you weigh your options? Contact our partners at Capital Home Loans!