When you apply for a mortgage, you may hear the word mortgage points thrown around. Many people assume they are ‘bad’ and try to avoid them.
This guide breaks the stigma surrounding mortgage points, helping you understand the truth of how they work.
Mortgage Points are Prepaid Interest
Want another way to look at mortgage points? Consider them prepaid interest. Most lenders offer lower interest rates when you pay points. Why? Because they make the money upfront, rather than collecting bits and pieces monthly.
If you pay one mortgage point, you may secure a slightly lower interest rate. Each lender discounts the rates differently, but paying points brings your rate down.
Mortgage Points Help Make up for Application Issues
Do some of your qualifying factors not quite say ‘I’m a great borrower’? Paying points may help lenders approve your mortgage application. You may not get the lower interest rate in this case, but you’ll get the approval you need.
Paying points pays lenders some money upfront. It’s a guarantee of ‘some money’ they’ll make by lending you money. If you default on your loan, the lender offset its losses by collecting money at the closing as points.
How to Calculate Mortgage Points
Want to know how much a mortgage point will cost you? It’s simple math.
Each point is worth 1 percent of your loan amount. If you borrow $100,000, for example, one point equals $1,000 and 2 points equals $2,000.
If you pay points to buy your interest rate down, you can determine how long it would take you to reap the savings by seeing how many months of savings it would take to pay off the points. For example, if you save $50 a month buying the rate down and the points cost $2,000, it would take 40 months or just over three years. If you’ll be in the house much longer than three years, it’s likely worth it.
You Pay Points at the Closing
Keep in mind, you pay the mortgage points at the closing. This is in addition to your down payment and other closing costs. If you agree to $2,000 in points, for example, you increase your closing costs by $2,000.
Mortgage Points may be Tax Deductible
You may be eligible to deduct your mortgage points on your taxes on loan amounts up to $750,000. You may deduct them the year you pay them if:
- You use the mortgage to buy or refinance a home
- The points paid are usual and customary for the area
- You pay for the points out of pocket and don’t roll them into your loan amount
If you must pay mortgage points, don’t let it stop you from securing a mortgage. Points help you save money in the long run and may even lower your tax liability.
Even though mortgage points have a bad reputation, they help homebuyers realize their dreams of buying a home. Points make your payments lower and/or make your chances of loan approval increase. Check out the benefits of paying points on your next mortgage to see how much you can save.
