2671: What Are Mortgage Points (And Should You Buy Them)? by Jeff Rose of Good Financial Cents

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[00:00:57] You may have heard how mortgages come with points, a polite synonym for fees or premiums.

[00:01:04] Your lender charges for loan, origination or refinancing. Sound familiar?

[00:01:09] Why would you want points? Well when you buy a point or two along with your mortgage,

[00:01:14] you get a lower interest rate and lower monthly payments. Pay $3,000 for a point now

[00:01:20] and you could save that much and more later on over the course of the loan.

[00:01:26] So isn't a no-brainer? Well, let's talk about that.

[00:01:30] Our mortgage points pointless. The math on points is simple. One point equals one percent of

[00:01:36] the amount of the loan you take out. Two points equals two percent and so forth.

[00:01:42] While the math is easy, the real value of a point is not always so simply calculated.

[00:01:47] But it may seem pointless. The problem is points don't move when you do.

[00:01:52] Who stays in one home for 30 years these days? If you have a 30 year loan and you sell your

[00:01:58] home and move five years from now, you lose the points and the benefits with them.

[00:02:03] The same applies when you refinance. There's also the interest rate aspect.

[00:02:09] Let's say you buy two points at six percent interest when you get your mortgage.

[00:02:13] What if two years later interest rates fall to four percent? You'll regret your purchase.

[00:02:18] There are three types of mortgage points you may encounter. Discount points,

[00:02:26] what we're going to focus on, origination points and negative points.

[00:02:30] The bulk of our discussion is going to look at the advantages and disadvantages of discount points.

[00:02:36] These are the points which lower your interest rate. Before we dig into the discount points,

[00:02:42] I'm going to quickly explain origination points to help you understand the difference.

[00:02:47] They're basically the fees you have to pay before the insurance company will give you a mortgage.

[00:02:52] They're essentially a nice way of saying fee. Should you buy points or are they a scam?

[00:02:58] When you're going through the mortgage application process, there are dozens of factors

[00:03:02] you need to consider. It can be a confusing process. When trying to decide if you should buy

[00:03:08] mortgage points, there's a simple equation you should do. You need to calculate how long it will

[00:03:13] take you to break even. Don't worry, the math is simple. Take the cost of the points and then

[00:03:18] divide the number by how much you'll save every month. The number you get is how many months it will

[00:03:24] take for you to break even. If you want to make those points worth it, you'll need to be in your

[00:03:29] home past the break-even point. If you don't plan on being in your home for that long,

[00:03:34] then buying the points is a waste of money. The average homeowner stays in their home for 13.2

[00:03:40] years. Compared to 2020, that's down from 13.5 years. What this tells me is for most people,

[00:03:47] the points probably won't be worth the upfront cost, but every situation's different.

[00:03:53] Do those quick calculations and you can decide if it's worth buying a point.

[00:03:58] Our mortgage points tax deductible. Sometimes, usually points are amortized over the duration of your

[00:04:05] mortgage. That is, paid off in installment payments over the life of the loan. But you might be

[00:04:11] able to deduct the cost of these points at tax time. If you took out your mortgage to buy or refinance

[00:04:17] your primary residence, you could qualify for a deduction in the tax year you took out the loan.

[00:04:22] If your loan meets certain conditions, the IRS has a 9-point test and the key points are.

[00:04:30] Number 1. Points must be a percentage of a principal amount clearly defined on the settlement

[00:04:35] statement. Number 2. Points can be paid in place of separately stated amounts elsewhere on the settlement

[00:04:42] statement. Number 3. Funds supplied by the buyer plus points paid by the seller must be equal to

[00:04:49] or greater than points charged. Number 4. Points charged must not be excessive. And number 5.

[00:04:57] Charging of points must be an established business practice for such a mortgage.

[00:05:03] If you buy a home and the seller pays any points, you can deduct those points.

[00:05:07] If you're refinancing, there's no quick tax break. Points have to be amortized unless

[00:05:13] you're using part of the loan for home improvement than a partial deduction is allowable.

[00:05:19] Negative points. A lesser known point is negative points. These points are lender credits

[00:05:26] and they actually cause your interest rates to go up. Seems like an odd choice, right?

[00:05:31] If you use negative points, you don't pay for your closing costs out of pocket.

[00:05:35] Instead of paying your closing costs, you receive a higher interest rate. The closing costs will be

[00:05:40] paid by the higher monthly payments. Just like with mortgage points, you should decide how long

[00:05:46] you're going to be living in the home. If you plan on sticking around for 20 years, these points

[00:05:51] are going to be a waste of money. They work as an inverse. The bottom line. What are mortgage

[00:05:57] points and should you buy them? Mortgage points representing an upfront fee to lower interest rates

[00:06:04] may initially seem attractive, especially with the promise of lower monthly payments.

[00:06:09] However, the true value of purchasing points gets muddied when considering modern

[00:06:14] home ownership trends where the length of stay in a single home is often shorter than the break

[00:06:19] even point. Furthermore, fluctuating interest rates can also impact the perceived savings from

[00:06:25] points. The option of negative points offering a work around for closing costs at the expense of

[00:06:30] higher interest rates also presents a contrary avenue. Ultimately, the decision to buy points is

[00:06:37] a personal one, hinge on individual financial circumstances and long term living plans.

[00:06:43] It's prudent to engage with a mortgage professional to fully understand the implications

[00:06:48] before making such a decision. You just listen to the post titled What Are Mortgage Points and

[00:06:58] Should You Buy Them? By Jeff Rose of GoodFinancialSense.com, and I'll be right back with my commentary.

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[00:08:19] While I didn't buy mortgage points when buying my house,

[00:08:22] I do recall considering it. The challenge for me was just the uncertainty. Because if you buy

[00:08:28] points and then the interest rates drop, you would have been better off waiting and then refinancing.

[00:08:33] I was also buying a house far below my means. My mortgage payment was already very low,

[00:08:39] and I bought at a time when interest rates were already below 5%.

[00:08:43] I didn't feel the need to pay more upfront for a lower interest rate.

[00:08:47] Another thing to consider is if you have the cash on hand to buy points.

[00:08:52] Many people struggle to pull together a 20% down payment or struggle to have the financial bandwidth

[00:08:57] for the repairs and maintenance required for home ownership. If buying points affects your

[00:09:03] ability to put 20% down, the added cost of PMI might negate the interest savings.

[00:09:10] If you want to save on interest but maintain flexibility, perhaps making extra principal

[00:09:14] only payments on your mortgage is the way to go. You'll save on interest over the life of your

[00:09:19] loan without having to pay it upfront. As with most things in personal finance,

[00:09:23] it really depends on your situation, so it's always best to run the numbers as Jeff recommended

[00:09:29] in this article. And that should do it for today, have a happy rest of your day, and I'll see you on

[00:09:34] the Friday show tomorrow where your optimal life awaits.