Mortgage lenders use a specific set of criteria to determine the interest rate for a home loan. Your credit profile and the current market rates are among the most influential factors.
A popular method that many homebuyers use to lower their interest rate is by buying mortgage points. The process often called “buying down the rate” can reduce your monthly payments and save you money over time.
While this may be a good strategy for some, it does increase your upfront costs when buying a home. So, do you need to buy mortgage points for your loan?
In this article, we'll explore mortgage points to determine if they are the right option for you.
Every mortgage point you buy will reduce the interest rate by a predetermined amount set by the lender. Over time, savings on the interest payments will surpass the cost of the points at the time of the purchase. The longer you stay in the home, the more savings you will see from reducing the mortgage rate.
How Do Mortgage Points Work?
When you take out a mortgage loan, you may discuss with your mortgage lender about buying mortgage points.
For every mortgage point you purchase, your loan's interest rate will be reduced by a predetermined percentage. The discount rate can vary depending on the lender, but mortgage points typically reduce the initial interest rate by 0.25% for each point.
Most lenders will allow you to buy fractions of a point and place a maximum cap on the number of points you can buy. Buyers can usually purchase between one to three mortgage points.
Your lender will typically offer discount points during the application process. The options for the purchase of mortgage points will be detailed on the official estimate, the closing disclosure, and any other pertinent documents related to the sale.
Buying mortgage points is a long-term investment. Paying at the time of purchase to lower the interest rate for the life of the loan will significantly increase closing costs. A one-time processing fee is also added to the closing costs.
How Can You Benefit From Mortgage Points?
If you can afford it and are planning on staying in the home for a long time, taking advantage of discount points is an effective way to save thousands of dollars off the home's cost.
When you buy points, you will be left with a lower interest rate. A lower interest rate results in lower monthly payments, saving you money to use for other areas of your budget. The longer you stay in the home, the more you benefit from purchasing mortgage points at the time of the loan.
How Do Mortgage Points Affect Your Taxes?
Purchasing mortgage points can also save you money on federal and state taxes.
The IRS considers discount points a part of your prepaid mortgage interest, making it a tax-deductible expense. Your loan will need to meet a list of requirements and qualifications from the IRS, including:
- You live in the home most of the time.
- Paying points is an established business practice in the area where the loan was made.
- Points are not more than the amount typically charged in that area.
- The points are not used for items like appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
- You did not borrow the funds from your lender or mortgage broker to pay for the points.
- The amount for the points is clearly detailed on your settlement statement.
The process of claiming your mortgage point costs as a tax deduction is relatively simple for most people. You will need to fill out Form 1098 detailing your mortgage point expenses and transfer the amount to Form 1040 Schedule A.
What Are Adjustable-Rate Mortgage Points
Adjustable-rate mortgages (ARM) allow the lender to change the interest rate on a home loan at any time. The rate and your monthly payments can increase beyond your original agreement. Furthermore, any mortgage points you purchase with an ARM may only apply for the initial fixed-rate period and the duration of the loan after adjustment.
An ARM is best if you are not planning on owning the home on a long-term basis. However, these loans are not ideal for long-term investments. This type of loan offers the benefit of lower payments for a shorter amount of time before.
Should You Pay For Mortgage Points?
Purchasing mortgage points is essentially a way to pay some of your interest rate in advance. The goal of buying discount points is the long-term savings on interest payments. Every homebuyer's situation is different and purchasing mortgage points is not the best option for everyone.
Discount points are ideal if you plan on the home loan being a long-term investment for your primary home. If you live in the home for many years, you can see significant savings from the lowered interest rates over time.
How To Find The Break-even Point
The break-even point is reached when you have paid off the initial expense for the mortgage points. Figuring out the break-even point will help you determine if buying mortgage points is the right decision for your circumstances. If you do not move or refinance the home before your break-even point, the savings could be substantial going forward. However, if you do move out of the house or wind up refinancing, a mortgage point purchase would not be in your financial best interest.
To determine how many payments it will take to break even, divide the upfront cost of the mortgage points by the savings that come from the rate reduction. Taking the time to figure out your payment schedule with and without points will help determine what is best for you.
Seeing exactly how long it will take to reach the break-even point allows you to get a clearer picture of the effects of mortgage points on your home loan.
Work With A SimpleShowing Agent & Get $5,000 Towards Your Closing Costs
The decisions you make regarding your home loan will impact your finances for years to come. The process for determining whether to buy mortgage points can be a confusing and complicated experience – especially if you don't have a lender you trust.
When you buy a home with SimpleShowing, we can connect you with our partner lenders to explain everything you need to know about mortgage points and help you determine which option is the best for you. Plus, SimpleShowing already gives their clients $5,000 towards closing costs on average which will help offset your upfront costs if you do decide to buy mortgage points.
To learn more about whether mortgage points are right for you, contact us at SimpleShowing, and get started today.