A great deal of today’s homebuyers have found the prospect of buying mortgage points to be well worth the investment. With a mind for due diligence, mortgage points can potentially save buyers thousands of dollars over the life of the loan in exchange for an upfront fee. However, mortgage points are not meant for everyone. Whether or not mortgage points will work for you is entirely dependent on several factors, not the least of which include how much the points cost, how long you’ll be in the home, and whether or not you are comfortable paying an upfront fee.
Points on a mortgage award buyers one more way to finance a property. More specifically, mortgage points are upfront fees that may be paid to the loan originator in exchange for reducing the interest rate. Otherwise known as “buying down the rate,” mortgage points are often used to lower monthly payments by paying more at the time of signing. Lenders like the idea of points because they recoup more of the loan upfront, and borrowers appreciate the resulting lower monthly payments.
While mortgage points may differ from lender to lender, it’s quite common for a single point to be worth the equivalent of 1% of the entire loan amount. For example, one point on a 30-year loan of $100,000 would translate to $1,000. That said, it is entirely possible for lenders to charge as many point as they see fit; they can charge anywhere from zero points to several points. It is also worth noting that points aren’t always round numbers. A lender could just as easily charge 1.5 points, or even 0.5 points at the time of signing.
The amount of points purchased will impact monthly mortgage payments moving forward, but I digress. Mortgage points don’t always end up saving borrowers money in the long run. In order to make sure buying down the rate is worth your while, you should learn how to calculate points on a loan.
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Learning how to calculate points on a loan isn’t all that difficult. In fact, points are disclosed on the Loan Estimate, which borrowers will receive before they even sign any closing documents. The borrower will be made privy to the cost of points on their own loan several days before any settlements are made.
That said, the trick isn’t learning how to calculate points on a loan (the lender will do that for you), but rather determining if they’re worth the upfront investment or not.
To determine if points are worth your while, you’ll need two things: the cost of the points and the amount the points will save you each month. Once you have these figures, divide the cost of the points by how much you will save on each monthly payment. The number you end up with represents how long it will take for the monthly savings to equal the total cost of the points.
In the event the resulting number is less than the duration of the entire loan, the points may be worth the upfront fee. However, if the breakeven point doesn’t take place until after the loan has been paid off, points may not be the best option for you.
Let’s say, for example, that it will cost $3,000 to purchase three points. Now, let’s say that by purchasing said points the borrower will save $45 each and every month for the duration of the loan. In order for the points to be worth their purchase, the borrower will need to keep the property for at least 66 months to reach the break even point. In other words, it’ll take about 66 months until the savings make the points worth the investment. Borrowers with a 30-year loan will find the points well worth the upfront cost, whereas anyone staying in the home less than 66 months will find that the points actually cost them more.
The biggest reason borrowers should consider buying points is to avoid paying more over the life of a loan. It is entirely possible for mortgage points to simultaneously cut down monthly payments and the total amount owed on the loan. Lowering the interest rate over a 30-year period can amount to thousands of dollars in savings. That said, there are more things to consider when looking at mortgage points than cost.
For starters, those thinking about purchasing mortgage points need to pay special considerations to their resulting cash position after the points are acquired. After all, points will typically coincide with a large upfront cost. A great deal of investors would argue that the money spent on points could be better utilized elsewhere, preferably on subsequent investments.
It is entirely possible to use the money that would have been spent on points to acquire subsequent assets (assets with the potential for greater returns than the amount saved initially paying for the points). It is important to weigh the cash flow opportunities you would receive from a lower monthly payment against the investment opportunities that spend could provide. There is a large contingent of buyers that would rather maintain a liquid cash position than investing in upfront points. However, the average homeowner may find that the risks associated with additional investments aren’t worth losing out on a lower monthly mortgage payment.
When determining whether or not you should buy points on a mortgage, weigh your options carefully. If being able to pay off your mortgage each month outweighs the risks associated with maintaining a liquid cash position, you may be more inclined to purchase mortgage points. If, on the other hand, you have opportunities to make smart investments elsewhere, you may want to think about skipping mortgage points.
Purchasing a house represents one of the largest financial decisions most people will make in their entire lives. As a result, prospective homeowners should evaluate whether or not buying mortgage points is worth the upfront cost. When market indicators are in your favor, buying down the interest may be a great move over the duration of a 30-year loan. On the other hand, using all your cash on upfront fees prevents you from investing your money elsewhere. Following these guidelines, as well as basing your decision on your own long-term goals, will allow you to make the right choice when it comes to mortgage points.