4 Must-Know Facts about Mortgage Points
With mortgage rates having tripled over the past few years, many homebuyers may be concerned about the impact on their long-term financial commitments. And many first-time buyers may wonder if they will ever get their dream home. Even worse, people are sitting on the sidelines while both interest rates and home prices go up!
Fret not, these perceived negatives can be turned into a benefit by understanding the strategic use of mortgage points.
What are Mortgage Points?
When you obtain a mortgage, your lender may require points or points can be paid voluntarily by either the buyer or seller.
What’s the difference? And how do they work? And how can you optimize the opportunities available given the current lending environment to qualify for more?
Here are the four things you need to know about mortgage points before signing any paperwork:
#1: Discount vs. Origination Points
Starting with the basics; there are two common types of mortgage points — discount and origination.
Discount points are used as prepaid interest on your mortgage loan. The more points you pay, the lower your interest rate. This is also called “buying down the rate.”
Most borrowers can pay anywhere from zero to several mortgage points, depending on their desire to lower their interest rate. Each mortgage discount point typically lowers your loan’s interest rate by 0.25 percent, reducing a 4 percent mortgage rate to 3.75 percent for the life of the loan.
Origination points, on the other hand, are used to cover the lender’s cost of processing the loan. They are used as a simple and straightforward way to handle closing fees. These points are negotiable, though the number required by your lender may vary.
#2: When to Pay Discount Mortgage Points
What options do you have as rising rates start affecting affordability and when does it make sense to buydown the mortgage rate with discount points? Let’s take a look.
Say you qualify for a $450,000 mortgage and you find a home you absolutely love that requires a $500,000 loan – what to do?
Well, you can choose from two types of buydowns: a permanent buydown and a temporary buydown.
With a permanent buydown, your points will lower your interest rate over the life of the loan, whereas a temporary buydown only applies the discount points to your loan for a short period.
Permanent buydowns are typically purchased by the buyer. While temporary buydowns may be paid by the seller or a builder as an incentive.
One temporary opton is called a 3-2-1 buydown
Let’s take a look at one with a $500,000 loan and an interest rate of 8%.
- In year one your monthly payment is based on an interest rate of 5% or $2,684
- In year two your monthly payment is based on an interest rate of 6% or $2,998
- In year three your monthly payment is based on an interest rate of 7% or $3,327
- Finally in years four through thirty you’re back to 8% or $3,669.
In this case the buydown points temporarily prepay the missing interest in years one to three. Hypothetically speaking it could cost anywhere to about 4.8 points or about $23,977.
This option makes sense if you need the flexibility and extra cash flow early or, you think interest rates may go down after year three. Or, if you intend to stay in the home for four years or less.
The permanent buydown option
With a permanent buydown you can take that same $23,000 and spend it purely on discount points to permanently buy down the interest rate for the life of the loan.
Again, depending on the circumstances and the lender, this could buy down the interest rate say 1.5%. Which in this case you might go from 8% down to 6.5%.
- At 8% your monthly payment would be $3,668.82
- At 6.5% your monthly payment would be $3,160.34
- That’s a potential savings of about $508.48 every month
In this scenario your discount point break even date would potentially be 44 months. In other words 44 months is your breakeven point, where the payment and interest savings exceed your refinance closing costs. Each month after that you’ll have saved more money for buying 4.5 points.
Of course, the longer you stay, the more your initial investment will pay off.
#3: Rebate or Negative Points
What happens if, at closing, you can’t afford to pay the origination points required by your lender? At this point, the time has come to consider rebate or negative mortgage points — a term often used when describing a no-cost mortgage.
These mortgage points are offered when borrowers don’t have much cash on-hand at closing. In exchange for a higher interest rate, your lender will remove points from your closing costs.
For example, if your lender requires four origination points at closing and you can only afford one, you might be given three rebate points in exchange for a 1% increase in your interest rate.
The credit given in negative points cannot exceed the mortgage closing costs, blocking borrowers from using extra points to provide a bigger down payment. In addition, negative points can’t be used to pay recurring fees like property tax.
#4: Other Important Facts
Here, we’ve listed a few last-minute facts you should know about mortgage points before making the leap:
- While you’ll receive an interest rate reduction for purchasing points, the number associated with this reduction is determined by the lender and marketplace you choose. Put simply, you won’t know your final rate until you meet with a lender.
- Because there are possible tax benefits to purchasing mortgage points, you should get in touch with a tax professional. This way, you’ll get the biggest bang for your buck.
- When the time comes to choose between making a down payment and buying points, don’t make a decision without running the numbers. A lower down payment could mean required private mortgage insurance (PMI) — which can end up being more expensive.
- For adjustable-rate mortgages, the discount offered on your loan interest rate may only apply during your first fixed-rate period. It’s important to ensure your break-even point comes before this period expires. Otherwise, you might be digging yourself a deep financial hole.
Contact an Expert to Learn More
This blog post only scratches the surface of what you can do to overcome today’s higher rates. At Embrace Home Loans®, we take pride in our extensive knowledge on mortgages of every kind. We’d be happy to examine all your options with you.
Contact us today at (888)-907-6261 and let us help you find your dream loan!