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!