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Increase your closing costs to decrease your interest rate.
When you are purchasing a home, you have a lot of decisions to make. One of them is whether you want to increase your closing costs and lower your interest rate with mortgage points, or discount points.
If you have extra cash on hand and plan to stay in your home a long time, it may make sense to purchase a point or two, but only if you’re going to stay in your house for a certain number of years, past what is called the break-even point, at which point you’ll start saving money on interest.
A mortgage point is equal to 1% of your mortgage loan, and buying points is a way to lower your interest rate.
Also called a discount point, a mortgage point is an amount that you pay up front to your lender as part of your closing costs to lower your loan’s interest rate. Using mortgage points can also be called “buying down” your rate. Depending your mortgage lender, it may also be possible to buy a fraction of a mortgage point.
(Want to know how much house you can afford? Try our mortgage calculator.)
There isn’t a set amount that one point will lower your interest rate; it varies by lender. If you’re interested in mortgage points and lowering your interest rate, ask for a rate sheet to show available interest rates and corresponding mortgage points.
The way points work is that you're essentially paying part of your future interest ahead of time by making a large payment up front. If you buy one point (1%) on a $100,000 loan, it would cost you $1,000 up front, but in the long run it could save you thousands of dollars.
Lenders offer points as a way to get cash in hand faster; they’re also lowering their risk that you’ll refinance, sell, or even default before you break even on the points.
Points are factored into your annual percentage rate (APR), which is your mortgage interest rate plus other costs associated with your mortgage, including points and fees. Points don’t decrease your principal; that’s what your down payment does.
The best way to understand how points work is through an illustration. Let’s say you’re taking out a $100,000 loan and you’re offered a 5.25% interest rate. According to the rate sheet from your lender, lowering the interest rate to 5% would cost one point.
|No points||1 point|
|Cost of points||$0.00||$1,000.00|
|Months to break even||N/A||100|
|Total cost after 30 years||$196,806.51||$193,256.49|
|Total payment savings on 30-year loan||N/A||$3,550.02|
Read more about how mortgages work.
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There are three main reasons that people choose to buy mortgage points:
Purchasing a mortgage point adds an expense to your closing costs, but since it lowers your interest rate, it will lower your monthly mortgage payments. A lower monthly payment can free up room in your budget to pay other bills.
Once you break even, if you continue to stay in your home for many years, you may end up saving thousands of dollars in interest.
Mortgage interest on a home you live in is tax-deductible, up to $750,000, and since points are prepaid interest, they may be deductible, too. The IRS or a tax advisor can help you find out of your points are deductible and give personalized advice on deductions.
Learn more about claiming the mortgage interest tax deduction.
The decision to purchase mortgage points is based on your individual circumstances.
The first thing to decide when calculating whether buying down your rate with mortgage points is right for you is whether you have enough cash on hand for them to even be an option.
If you do have the cash, then it’s time to do some math in order to decide whether purchasing mortgage points and lowering your monthly mortgage payment is the best use of that money.
A mortgage points calculator helps tell you how long it will take you to break even — that is, start saving — if you buy points. The further you get away from that break even point, that is, the longer you have your home and your mortgage, the more you’ll save.
Another option is to put any additional cash towards a larger down payment. If you can pay 20% or higher as a down payment, then you don’t have to pay mortgage insurance, which can be expensive. Plus, a higher down payment means your principal will be paid-off sooner so you’ll pay lower interest over time anyway. Work with your lender or financial advisor to do the math and see what’s the right choice for you.
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