Buying a home or refinancing a mortgage is a significant financial move! Laura helps you understand discount points, when to use them, and tricks to cut the cost of becoming a homeowner.
Buying a home or refinancing a mortgage is a significant financial move! Laura helps you understand discount points, when to use them, and tricks to cut the cost of becoming a homeowner.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Hey, friends! My name is Laura Adams, and I appreciate you joining me for this weekly episode. If you're new here, I'm an award-winning personal finance author who's been hosting Money Girl since 2008. I also work with select brands as an on-camera PR spokesperson, consumer advocate, and multimedia finance content creator.
Here on Money Girl, my mission is to help you get the knowledge and motivation to prioritize your finances, build wealth, and have more security and less stress. If you like what you hear, please take a second to subscribe or leave a five-star rating or review, so we know if you're getting value from this free content!
And speaking of reviews, I quickly want to thank a listener who recently left this one:
Kbeatle says, "Long time listener still… Laura is great. I've learned so much from her over the years. Constantly refer back to her podcasts when I need them and share them with friends. Check out all the available episodes. There's probably one you're looking for."
Thank you so much, Kbeatle! I really appreciate your kind words and love that you're a long-time listener! I'm honored to have you in the community after all this time.
I love getting your feedback and money questions. And lately, I've received many questions about renting versus buying a home. As mortgage interest rates, home prices, and rents have increased, making the right housing decision has never been more essential for your financial well-being.
I want to point out a couple of recent real estate-related podcasts, including:
In today's show, I'll cover a trick you can use to lower your interest rate on a new mortgage or a refinance, called discount points or mortgage points. So, whether you're already a homeowner or considering buying a home one day, stay with me. You'll learn what discount points are and how to use them to lock in a lower interest rate and save some serious cash over time.
What are mortgage discount points?
When you start shopping and compare mortgages, you typically see rates with and without "points." Those discount points represent an upfront fee you can pay at closing in exchange for a reduced interest rate.
Purchasing one or more points means you prepay interest to get lower monthly payments over the life of your loan. The idea is that if you have the mortgage long enough, the money you save on interest should exceed the upfront points cost.
One discount point costs 1% of your mortgage amount. For example, if you're shopping for a $300,000 mortgage, one point costs $3,000, 1.5 points cost $4,500, and 2 points cost $6,000.
While the per-point interest discount you receive varies by lender, it's typically a 0.25% reduction. For example, if you're considering a $300,000, 30-year, fixed-rate mortgage at 6.5%, paying one point would knock the rate down to 6.25%.
Instead of paying about $1,900 per month at the 6.5% rate, paying one point would give you a lower payment of about $1,800 per month at 6.25%. Over the life of the loan, you'd save about $17,000 in interest.
If you bought two points with an upfront payment of $6,000 ($300,000 x 2%), your rate would come down to 6%, and you'd save about $35,000 in interest over the entire loan term.
Note that most homebuyers who opt for points buy between one and three. And most lenders put a cap on the number of points you can buy.
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Should you buy mortgage discount points?
Whether to buy points or not starts with whether you can afford them. Buying a home already comes with lots of closing costs, and many buyers don't have enough savings to cover more upfront expenses.
However, let's assume you can afford it. As I mentioned, paying a few thousand dollars for points could save you tens of thousands over the long run. The key is understanding your breakeven point, or when you go from being in the red to saving money. I'll talk more about breaking even in a moment.
In addition to paying less interest and lower monthly payments, points typically qualify as tax-deductible mortgage interest. However, that benefit is available only if you itemize deductions on your tax return using Schedule A. Homeowners can deduct a certain amount of mortgage interest, including prepaid points, to reduce their tax liability.
The IRS specifies that separate lender fees are not the same as mortgage interest. So, buying points to reduce your lender's origination fee doesn't count as a tax-deductible expense. You can learn more about mortgage points on the IRS website or consult a tax expert, mortgage lender, or real estate professional.
What are the downsides of mortgage discount points?
There are many upsides to buying points, but it's essential to understand the downsides. As I mentioned, a common challenge is being short on savings and unable to afford them. Our current environment's high home prices and interest rates can stretch budgets even for minimum closing costs without points.
So, buying points isn't wise if you don't have extra funds to maintain a healthy cash reserve. Don't forget your monthly payment includes principal, interest, property taxes, and homeowners insurance. Be sure you clearly understand how much home you can afford before committing to a mortgage.
Another con for points could be not breaking even. That's when your interest savings exceed what you paid for points.
Let's go back to my previous example, where you get a $300,000, 30-year, fixed-rate mortgage at 6.5% and pay $1,900 monthly. If you bought one point for $3,000, you'd discount the rate to 6.25%, reducing your payment to about $1,800, a $100 per month savings.
To break even, you'd need to make payments for 30 months or three and a half years ($3,000 cost / $100 savings = 30 months). If you sold the property before owning it for 30 months, you'd lose money buying points. So, if you're unsure how long you'll stay in your home, buying points may not help you.
Another potential downside is buying points before interest rates go down. That's because you could refinance your mortgage for a lower rate (if you have enough home equity) and skip paying for points.
However, refinancing a mortgage comes with costs, too. Depending on your mortgage type, income, credit, and lender, they could range from 2% to 6% of your loan balance.
Be aware that every financial move comes with an opportunity cost for doing something else with your money. For instance, paying $6,000 on points could save $35,000 on mortgage interest. But what if you invested $6,000 for 30 years with an average 8% return? That would allow you to earn $60,000, much more than your interest savings.
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The bottom line is that points can save money over the life of a mortgage, but they aren't for every homebuyer. Buying discount points doesn't make sense when you:
Can you ask a home seller to pay points?
One solution for buying points, even if you can't afford them, is to negotiate with a seller to pay them. For instance, you could make a purchase offer on a home, asking for a lump sum payment from the seller at closing to cover some or all of your points.
Sometimes, getting a seller to pay points could save more than offering a lower purchase price. But lenders may have rules about who can pay points and how much, so discuss it with them first. If they give you the green light, let your real estate agent know how much you need a seller to chip in to make a deal work.
Getting a mortgage is a big financial decision, so don't miss the opportunity to use points when it's wise for your situation. And remember that just about everything in real estate is negotiable, so be willing to make creative, win-win offers!
I'd love you to connect with me on Twitter @lauraadams or Instagram @lauradadams. And LauraDAdams.com is my personal site where you can use my contact page and learn more about my work, books, and money courses.
As always, you can leave a comment or money question by calling 302-364-0308 to leave a voice message. Or send an email using my contact page at LauraDAdams.com.
That's all for now. I'll talk to you next week. Until then, here's to living a richer life.
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