Should You Buy Points to Lower Your Mortgage Rate?
Potential homeowners have seen mortgage rates rise more than two percentage points since the beginning of the year, as measured by Freddie Mac.
The average rate for a 30-year fixed home loan is 5.54% this week, up from 2.78% a year earlier, Freddie Mac said on Wednesday. The average 15-year fixed home loan rate rose to 4.75%, up from 2.12% a year ago.
That steep gain is causing more home shoppers to look for ways to minimize their monthly payments, including paying upfront fees to secure a lower interest rate, known as "paying points" or "buying down the rate."
What Are Mortgage Points?
Mortgage points, also called discount points, give borrowers a lower mortgage rate in exchange for an upfront fee. The cheaper rate lasts for the duration of your loan term.
The cost of each point equals 1% of the loan amount. So, one point for a $300,000 loan equals $3,000. Points are a significant upfront cost, but the expense can be worth it for some homebuyers.
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When It Makes Sense to Pay Points
The decision to buy mortgage points or not often depends on how long you plan to stay in the home. If you'll be there long enough to save money, then it’s worth it. But if not, you are better off sticking to the advertised interest rate.
“Generally speaking, if you plan to stay in your home for a significant amount of time, it may make sense to buy down your mortgage rate,” said Alan Harder, a mortgage broker in British Columbia.
A significant amount of time equates to at least five years for Harder. The longer period of time gives you the chance to recoup the upfront cost of the points in the form of a lower interest rate. But the specifics of your home loan payment will impact when that breakeven point comes.
When It Doesn't Make Sense to Buy Down the Rate
Buying mortgage points doesn’t make sense for every situation.
“If you think you may sell your home in the near future, it may not make sense to buy down your mortgage rate,” said Harder. That’s because you might not recoup the costs of buying the points if you sell the home soon.
Another reason to skip mortgage points is your available funds. Homeownership often comes with unexpected costs. When you own the home, you can’t just call a landlord when a critical appliance or home system needs repairs. Instead, you’ll have to cover that expense.
If you don’t have some emergency savings on hand, any unexpected expense could throw a big wrench in your finances. Before using your available funds to purchase points, consider the impact on your financial cushion. According to Consumer Reports, many financial experts recommend keeping three to six months of emergency savings on hand. Keep this benchmark in mind before moving forward with a mortgage points purchase.
How to Find Your Breakeven Point
The decision to buy mortgage points or not boils down to the numbers.
Purchasing mortgage points is an upfront cost. It will often take several years to recoup the costs. But after this breakeven point, you’ll save money for the rest of the loan term.
For example, let’s say you take out a $200,000 30-year fixed-rate home loan with a 6% interest rate. Without paying any mortgage points and assuming you have a good credit score, your monthly payment would be $1,541.
You have the cash available to buy two mortgage points for a total upfront cost of $4,000. That drops your mortgage rate to 4%, leading to a monthly payment of $1,296.
In this situation, you save $245 per month on your mortgage payment. You can divide the total upfront costs by those monthly savings to determine your breakeven point. In this case, your breakeven point is 16 months.
Every month after the 16-month mark, you’ll save $245. So, if you plan to stay in the house for 30 years, you’ll save a total of $84,280 over the life of the loan. But if you only plan to stay in the home for a year, you wouldn’t recoup the costs of buying the mortgage points upfront.
Want to run the numbers for your situation? Use an online mortgage payment calculator to map out your breakeven point.
When finding the breakeven point, it helps to ask yourself some questions about your homeownership intentions.
Jeffery Loyd, principal at Mortgage Acuity in New Jersey, recommends asking yourself, "Are you buying your forever home or a starter home that you will grow out of? Are you buying a home in a school district with a great high school? Or will you be moving once the kids are ready for middle school?"
Of course, Loyd recognizes that life can be unpredictable. But mapping out your plans for living in the home will greatly impact your breakeven point. For example, the difference between buying a starter home that you plan to sell in 3 years and a forever home changes the math in a big way.
“Ultimately, it's important to crunch all the numbers and make a decision that makes financial sense for your individual situation,” said Harder.