Mortgage rates are always a hot topic in the news. Whether they are up or down they are newsworthy. There is a way to save on your mortgage and get a better great rate, regardless of whether rates are rising or falling.
Mortgage points have always been a source of confusion, and fear for many borrowers. When I was a mortgage broker years ago, just the mention of a “point” would cause a client to cringe. As a Chartered Financial Analyst with 22 years of experience investing in real estate, I have analyzed many mortgage scenarios.
But points shouldn’t be scary. They are a powerful tool that can help you save significantly over the life of a loan.
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What Are Mortgage Discount Points?
A mortgage discount point is simply paying 1% of the loan amount for a lower interest rate. By paying to lower your interest rate you are decreasing the lender’s risk by giving them money upfront. You can buy several points.
The benefit to you is you have a lower interest rate on the large amount of money you are borrowing to buy your house.
Pros And Cons Of A Mortgage Discount Point
The cons of a mortgage point are you need more money out of pocket, or to pay less towards the down payment. Another con is mortgage brokers are afraid to explain how great points are because they are more complex and the broker doesn’t make anything additional off of them.
The pro is you have a lower interest rate. This is a big pro.
Who Should Consider A Mortgage Point?
A good candidate is anyone that understands what they are and plans to live in the house for long enough to recoup the cost of the point. A bad candidate is anyone who plans to move quickly.
What About PMI?
Private mortgage insurance (or PMI) is another scary word for borrowers. Typically if you put less than 20% down you need to pay Private Mortgage Insurance. PMI is insurance to protect the lender if you foreclose. You pay the premium monthly until you reach a certain level of equity, usually around 20%.
But here’s the thing. PMI goes away. Plus by buying your mortgage rate down you are paying more each month toward the principal. That means you are building equity quicker, and PMI will be canceled sooner.
After the PMI is canceled, you still realize the benefit of lower interest rates if you bought your rate down by paying discount points.
How Do I know If A Mortgage Discount Point Is Right For Me?
Ask your mortgage broker to calculate the break-even point of when you’ll recoup the cost of the points. If you plan to live in the house past that date, buy points. If you plan to move before then don’t buy points.
In the last house we bought, we even paid more towards points instead of a down payment. The PMI went away quickly (less than 2 years). The owner of the mortgage company said it was the best mortgage he had ever seen. (Our rate was only 2.3% in 2016, at the same time our Ally savings account was paying us 2%).
Whether points will benefit you or not depends solely on how long you will be there. It’s a math problem.
Is There An Alternative To Mortgage Discount Points?
An alternative is a larger down payment. This is much easier to explain and not as scary so lenders typically stick with recommending larger down payments. But if you are going to be in the home for several years, then discount points tend to be better financially.
Discount Points Shouldn’t Be Scary
If you understand what a discount point is, and have a lender that will calculate the break-even, then discount points are great. Buying mortgage discount points can save you tens of thousands of dollars over the life of a mortgage.