What Are Points When Refinancing a Loan?
Are you thinking of refinancing a loan to take advantage of a more affordable interest rate? If so, then it’s worth knowing that some types of loans, especially home loans, sometimes offer borrowers the chance to buy what are called called mortgage points. Purchasing these points upfront is a way to help lower your monthly loan payments in the long run, and it can be a helpful strategy to utilize if you’re planning to live in your home for the long term.
Before you head off to call your lender, however, it’s important to learn exactly what mortgage points are, how they work and how they can help you. They’re not for everyone, and you’ll want to have a thorough understanding of your personal finances and goals before you consider purchasing points. Join us for a crash course in mortgage points to get a good grasp on the basics and determine whether they’re a smart choice for you.
What Are Mortgage Points?
You can think of mortgage points as upfront fees you can pay to lower the cost of the interest on your mortgage for the length of your loan. In a way, they’re sort of like interest rate coupons that you can purchase. You don’t give them to your lender periodically for a discount or reimbursement, though. Instead, buying points is essentially like paying more right now to enjoy lower payments later.
Each point typically costs 1% of the total value of your mortgage and lowers your monthly interest rate by a certain percentage, usually between 0.125% and 0.25%. The cost of each mortgage point and the percentage by which it lowers your interest can vary between lenders. If points already sound like an option worth exploring, these are two of the most important factors you’ll want to ask about when you begin discussing a refinance with your lender.
There’s technically no fixed limit on how many mortgage points you can buy, but many lenders cap the limit at around four. It’s also good to be aware that you can purchase fractional points instead of, or in addition to, full points. In other words, rather than having to decide whether to buy either two or three points, you can buy 2.25, 2.50 or another fractional quantity. Just be aware that the balance of the points you want to buy is due at the time of the loan’s closing.
How Do Mortgage Points Work?
To explain how mortgage points work, let’s use an example to illustrate. Say that you want to refinance your home for $200,000 with a 30-year fixed-rate mortgage at 4.125% interest. If a lower monthly interest rate sounds more manageable in the long run and you have the upfront cash to spare, you could purchase points for $2,000 each.
So, you decide to go ahead and put up $4,000 extra in exchange for two points, each worth .25% off the interest rate. This effectively lowers your 4.125% monthly interest to 3.625% for the length of your loan. Purchasing mortgage points is sometimes called “buying down the lender” because it reduces the amount of interest you’ll pay over time, provided you intend to pay off the full mortgage.
Whether or not buying mortgage points is worth it for you will come down to what’s known as the “break-even point.” This is the point at which you’ve saved more money on a lower interest rate than you paid upfront to purchase the points. The break-even point is different for everyone and depends on things like the size of your loan, its term and your interest rate. Finding the break-even point involves a bit of math but is relatively simple. There are various tools available to make finding your break-even point easier. You can use a free online mortgage points break-even calculator to find out how long it might take for your points to pay off.
What Are the Pros and Cons of Mortgage Points?
Whether or not mortgage points are a good option for you largely comes down to your financial situation, including the amount of liquid money you have available to put towards paying for points. If you plan to stay in the home you’re mortgaging long-term (at least past the break-even point), mortgage points can be a great way to lower your interest rate in the long run. On the opposite side of the coin, if you don’t plan to stay in your home until you reach the break-even point, then purchasing them may not be your best play.
It’s also vital to consider how much each point is worth. While a 0.25% interest decrease might be worth paying for, if the decrease is on the lower end (say only 0.125%), then you might opt to keep your money in the bank.
Last but not least, some people argue that investing extra money upfront in your home could decrease the money’s value because you could invest it in the stock market instead (and hopefully earn greater returns). This comes down to your personal investing preference, however, as many homeowners would rather invest in a home that could eventually triple in value than take their chances on the market.
Whether or not investing in mortgage points is right for you will depend on a variety of factors. Some of these include:
- Whether or not they’re an investment you can afford to make
- The amount each point brings down your monthly interest rate
- Whether you plan to stay in the home until at least your break-even point
If you’re still on the fence about whether or not to invest in mortgage points or about how many to buy, then it may be time to sit down and do a bit of math. Start with your monthly mortgage payment and figure out exactly how much more your interest payments will be each month at your current rate. Then, figure in how much money you’d save each month if you bought one point, two points and so on. Compare the average monthly repayment amounts in each scenario. If you discover that springing for the points could significantly lower your bills in the long run, purchasing a few points may be the way to go — as long as you’re comfortable using your savings this way.