When you apply for mortgage refinance, most lenders will offer you the option of purchasing points. Understanding what are points in refinancing and how they are calculated will help you assess whether buying mortgage points is good strategy for you.
What Are Points When Refinancing?
Mortgage points are a way to lock in a lower rate of interest when refinancing your home loan. When you buy a mortgage point, you’re prepaying the interest in exchange for lowering the rate. Think of it as a fee you pay to lower the interest rate when refinancing. The goal is to pay less on the loan over term. Mortgage points are also called discount points.
How Mortgage Points Work
If you choose this option when refinancing, you have to first buy mortgage points. The cost of 1 mortgage point is calculated as 1% of the total mortgage amount you’re refinancing. So if you’re refinancing a mortgage of $300,000, one mortgage point will cost you $3,000. This amount that you will pay at closing.
First you’ll decide how many points you want to purchase when refinancing. Then, the lender will calculate the total cost and add that amount to your other closing costs. For every mortgage point you purchase, your interest rate will be lowered by a set percentage point.
Lenders vary in terms of the per-point discount they offer. Most lenders offer a .25% interest rate reduction for every mortgage point you buy. This is not unlimited. Lenders usually cap the number of points they’ll allow you to purchase.
Buying mortgage points has its advantages but it also has a few downsides that you should be aware of.
Pros & Cons of Mortgage Points
One of the biggest advantages of buying mortgage points is the money saving potential. Buying points lowers the rate of interest that you pay. Even a small drop in the rate can save you a substantial sum over the mortgage term.
Another advantage of buying points is that it allows you to lower the monthly payments. If you’re on a tight budget and can’t afford the monthly mortgage payments, buying points may be a solution. The lower monthly interest automatically lowers your monthly payments and reduces the strain on your budget.
A lesser-known benefit of purchasing points is the potential to save money on taxes. Mortgage interest is tax deductible. The mortgage points you buy are considered prepaid mortgage interest so you may be able to deduct the cost of the points on your taxes.
The downside of buying mortgage points is that it can increase your upfront closing costs by a few thousand dollars. You’ll need to have that cash on you to proceed.
Should You Buy Mortgage Points When Refinancing?
Paying a lower interest rate sounds great but it’s not the best option for all homeowners looking to refinance.
In general, the large upfront costs to buy mortgage points is worth it if you’ll live in the home long enough to see savings from the lower interest rate. Paying that $2,000 or $3,000 upfront could mean several thousands of dollars in savings over the mortgage term.
But, if you’re planning on selling your home or refinancing the mortgage again within a short time, paying for points may not be worth it. This is because it takes time to see significant savings with the lower interest rate.
Consider buying mortgage points if you have the cash to pay the upfront costs and only if you’re sure you’ll stay in the home long enough to break even.
Last but not least, take time to calculate the breakeven point before deciding to buy mortgage points when refinancing.