Understanding mortgages can be tricky with terms like interest rates, amortization, escrow, and PMI. Adding the concept of points can make it even more confusing. However, knowing whether to buy points can significantly impact your long-term savings or costs with your mortgage. Let’s break it down and provide a simple explanation.
**What Are Points?**
Points are fees you pay upfront to your mortgage lender to reduce your interest rate. This is why they are called “discount points.” Essentially, you pay money now to save on interest later.
Here’s how it works:
– Lenders usually offer a few options: a standard interest rate with no points, or lower interest rates with varying points.
– One point equals 1% of your loan amount. For a $200,000 mortgage, one point would cost $2,000, usually reducing your rate by 0.125% to 0.25%.
Points can also work in reverse. Lenders might give you points (essentially a discount) if you accept a higher interest rate, which can help cover your closing costs.
**Why Consider Points?**
Points can be thought of as putting your mortgage “on sale.” Paying a bit more upfront might save you thousands in the long run. But, just like any sale, sometimes it’s not worth it. The best way to decide is to calculate it.
**Example Scenario**
Let’s say you need a $150,000 mortgage. You’re given two options:
– A 30-year fixed-rate mortgage at 4.25% with no points
– A 30-year fixed-rate mortgage at 4.00% with 1.0 point
Both options have $3,000 in closing costs (paid out of pocket).
**Key Factors Affected:**
1. Upfront closing costs
2. Monthly payments over the mortgage term
3. Total interest paid over the mortgage’s lifetime
For buying points:
– You initially spend $1,500 more in closing costs
– Your monthly payments are $21.79 less
– You save $7,843.28 in total interest over 30 years
**Calculating Savings:**
To properly compare, you must consider the future value. Assume an 8% annual return rate:
– $1,500 invested now could grow to $16,403.59 in 30 years (a loss since it’s spent)
– Saving $21.79 monthly grows to $32,470.30 in 30 years (a gain)
The net benefit is $16,066.71, meaning the mortgage with points is better in this case.
**Refinance Example:**
Using real numbers for a 20-year refinance, let’s say:
– $1,446 given at closing could grow to $7,124.16
– Paying an extra $19.17 monthly loses $11,288.86 (more than the $4,599.72 straightforward interest)
The net loss is $4,164.71, making the refinance without points better here.
**Try It Yourself:**
If you want to try this calculation with your personal details, you can download an Excel worksheet designed for this purpose.
Exploring whether to buy points on a mortgage involves doing the math. Sometimes what the lender suggests may not be the best option for your financial situation. Feel free to share your experiences and outcomes!
**Related Reads:**
– Should you pay down your auto loan or mortgage first?
– Investing money vs. paying off your mortgage: which is better?
– My refinancing adventures
By understanding the impact of points, you can make more informed decisions about your mortgage options.
