As we move forward with our home purchase, this week was the occasion to discuss with our lender the purchase of mortgage points. Points can be a great investment, but not necessarily for everyone. So should you buy points on your mortgage?
Our closing is scheduled in 2 weeks, shortly after Thanksgiving, and we are getting quite excited to finally be done with all this paperwork and finally moving. Probably because of a very short preparation and lack of knowledge from my part, I realized I had not discussed the topic of points with our lender and how they could impact our mortgage. Don’t make the mistake I did, it could literally save you thousands of dollars!
What are Mortgage Points?
Points are an additional parameter of the mortgage offer from the bank that front-loads part of the interest on the mortgage at the time of closing. It can be advantageous for the bank or for the buyer, in the range of several thousands of dollars.
A point is equal to 1% of your loan value, so if your loan is 100,000$, a point will be equal to 1,000$. If you buy a 200k$ house with a 20% downpayment, the loan will be 160k$ and a point will then be 1,600$.
The trade-off is up-front cash vs better rate, long term
In exchange for points, the bank will adjust the interest rate of the mortgage. If you buy points, you increase your closing costs but the interest rate decreases (by 0.125% to 0.25% per point). If you sell points, your closing costs decrease but the interest rate increases (by similar percentages).
Typically, your bank will offer the default mortgage rate at 0 point (the baseline) and will allow a variation of +/- 2 points. In our case, each point had an impact of 0.18% on our 30-year loan at 4% for a maximum of 2.125 points.
The trade-off is up-front cash vs better rate long term and what is the break-even time horizon.
Does it make sense to buy Mortgage Points?
To make a decision whether or not to buy / sell points, you need to calculate the break-even point, in terms of years you’ll hold the property before it is sold or refinanced.
Assuming 1 point on your 200k$ with a 20% downpayment equals to 0.18%, if your mortgage is at 4% over 30 years:
- with 0 point, the monthly payment for Interest + Principal will be 763$ at 4%
- with the purchase of 1 point, the monthly payment for I&P will be 747$, will cost 1,600$ up-front and the interest rate will become 3.82%
What’s the break-even?
In our example, the difference is 18$ a month, so 1,600/18 = 97 month or 8.01 years.
As a point of reference, the median time a homeowner stays in his/her house before selling is now 10 years, even if the expected tenure is about 12 years according to the latest NAR report.
If you want to go a little further, you can also calculate the Return On Investment of buying points. In our case, we save 18$ a month, or 216$ a year for an initial cost of 1,600$, which is a return of 13.5%. Not bad.
The Bottom Line
Knowing if it is worth buying points or not comes down to how long you plan to own the property.
If you plan to:
- Own the property for a longer period than the break-even point, you will save money long term by buying points, in exchange of a small cost up-front.
- Own the property for a shorter period than the break-even point, you will save money short term by selling points, in exchange of a higher rate short term.
In our case, the break-even was around 8 years and we know we will rent it once we move, so it was more interesting for us to buy the points. For roughly 3000$ up-front, we will save upwards of 10,000$ on the total loan cost, with a rate at 3.62%. If we had thought of buying a house and sell it in 3 years, we would have sold points. But then, for such short periods, we would probably be better off renting.
Our lender was kind enough to update our loan paperwork to include the points less than 2 weeks before closing. So hopefully, for those of you in the process of ‘mortgage shopping’, you will be wiser than I’ve been and you’ll have a chance to negotiate this up-front!
-Nick
Congrats on the upcoming closing… and well done with the calculations before going into it. Unfortunately, we bought our house before we knew much of anything about these kinds of things. I believe points were part of the deal… but there was no calculating on our part. We just did what they said was “best.” Hopefully more people are going in more informed than we were! 🙂
I hear you Maggie! I had no idea either but I vaguely remembered something about these points and did some research. There are so many people involve in a real-estate transaction and so many conflicts of interest, starting with the buyer’s realtor, that what’s “best” is not necessarily in your best interest.
I guess that’s how we learn 🙂
Cool discussion. We are building a house as well and plan to close in February. We paid 50% down on the house and financed the rest. I had not thought of buying points, but now you have me thinking I should. Was it a pain to get them to add that at the last minute?
Congrats on the house Steve, building your own house must be such a great learning experience. How much time does it usually take to build one?
Adding the points last minute was actually at lot easier than I expected, it took us 2 days. We exchanged probably 6 emails on the various possibilities ($ cost of point + % discount on rate) and the next day they had revised our loan disclosure to e-sign.
Hey Nick — We signed the contract with the construction company in late April and the house will be done by mid February — so it takes about 9.5 months in total. That’s a lot longer than a track house would take but this is a custom home in a beach community where hurricane standards are higher — therefore it takes more time for permits and inspections.
I thought it would take a year, but 9.5 months sounds more reasonable. I like the sound of “beach community” and “building your own house”, that sounds like something I have on my bucket list 🙂 Enjoy and good luck with the lender on the points discussion!
I used the points for the first 2 times I finance my house. The payment was looking pretty high for it. Looking back, I should have done the 5 years arm, then refinance when the rate was at the lowest. Nonetheless, I still have pretty good rate right now.
Good luck with the process.
Hindsight is always 20/20 and you made the best decision you could at the time. I do not think rates can get much lower than they are today, but if they fall to Japan-levels (1.4% for 30 years, amazing) within the next 10 years, it would have been a better decision for us to take a 5y ARM. Or maybe rates will be a 5%-6% in 10 years and we’ll be happy we went that route.
If you have good rates now, I think there’s a good chance they will remain good for the foreseeable future.
These are great tips — thanks for sharing them! We have done it all three ways — we sold points on our first place, bought points on our “retirement home” (our current and future house), and stayed with zero points for our rental property. In all cases, it was just a question of when the break-even point was, and I think we’ve made the right choice with all of them. But you have to do that math to know for sure!
Great to hear from someone who’s done all 3, you guys are pros!
As you say, “as long as you do the math” you should be confident this is a smart decision. The challenge I think is that sometimes the paperwork can be so overwhelming, it is easy to skip over some details and make a decision based on feelings or worse, a recommendation from the bank.
“No-one cares more about your money than yourself”. Time spent doing our homework is always time well spent and you’ve given a good example of that.
You say that the decision depends on how long you plan to live in the home. I would argue that it depends more on how long you plan to keep your loan. If you buy points on a loan but then refinance it every 3 years, you are screwing yourself even if you live in your home for 30 years.
It’s semantics but I could see someone easily misunderstanding this nuance.
You are absolutely right, what matters is for how long you hold on to the loan, regardless of whether you live in the house or not, and refinancing resets the clock. If I used misleading language somewhere, let me know.
Thanks for highlighting the difference though, semantics are important and in this case critical. Good point!