If you're considering taking out a mortgage, you may have heard the term "points" before, but you may not be quite sure what they are or how they work. Simply put, points paid on a mortgage are upfront fees that a borrower (you, for example) pays to the lender in exchange for a lower interest rate on the loan. Whether you're a first-time homebuyer or an experienced homeowner looking to refinance, understanding the ins and outs of points can help you make an informed decision about your mortgage.
How Do Points Paid on a Mortgage Work?
Points, like other fees, are paid directly to the lender at the loan closing. However, their sole purpose is to lower your interest rate. Points are sometimes referred to as "discount points," because they allow the borrower to secure a lower interest rate on the loan in exchange for paying an upfront fee. The more points you pay, the lower the interest rate you can expect to receive.
Points are calculated as a percentage of the total amount of your loan. Each point is equal to 1% of the total loan amount, so if you take out a mortgage for $200,000 and pay two points, that would equal $4,000. Typically, paying 1% of the loan amount in points will lower your rate by 0.25%. Essentially, you’re paying 1% upfront to pay a quarter of a percent less per year in interest over the period you have the mortgage.
Does Paying Points Save Money?
Paying points on a mortgage can potentially save you money in the long run by securing a lower interest rate on your loan. It also requires a significant upfront cost. You'll need to weigh the cost of the points against the savings you'll receive in the form of a lower interest rate and monthly payment. It's also a good idea to shop around and compare offers from multiple lenders to see which one offers the best combination of interest rate and points.
To determine whether paying the points to “buy down your rate” makes sense, add your monthly savings at the lower rate to find the breakeven point. This is how long it will take you to save more in interest than you paid in points. For example, assume you’re applying for a mortgage of $100,000. One point (or 1%) of the loan value is $1,000. So, you would need to benefit by $1,000 in reduced interest payments to break even on buying that one discount point.
Are Points Paid on a Mortgage Tax Deductible?
In some cases, points paid on a mortgage may be tax deductible. Under the Internal Revenue Service (IRS) rules, mortgage points are generally tax deductible if they are considered "origination points" or "discount points." Origination points are fees that are charged by the lender for processing and underwriting a mortgage loan. These points are typically tax deductible as long as they are charged as a percentage of the loan amount and are not based on the value of the property being financed.
Discount points are fees that are paid to the lender in exchange for a lower interest rate on the loan. These points are also tax deductible as long as they are charged as a percentage of the loan amount and are not based on the value of the property.
To claim a tax deduction for points, you must itemize your deductions on your tax return and meet certain other requirements. For example, you must use the property being financed as your primary residence and the points must be paid in the same tax year as the mortgage loan.
It's important to note that the tax treatment of points may vary depending on your individual circumstances and the specific terms of your mortgage loan. You should consult a tax professional or refer to IRS guidelines for more information on the tax deductibility of points paid on a mortgage.
How Do I Know If Paying Points Is Worth It?
Whether or not it is worth it to pay points on a mortgage will depend on your individual circumstances and financial goals. Knowing how long you intend to keep the loan — without selling or refinancing it — can help you weigh the value of paying points.
- If you’re planning to relocate in less than three years, you probably won’t recoup the cost of paying points.
- If you’ll be in the property for five or more years, then paying points will probably make sense and save you money.
Consult with a Trusted Lender
As consumers, you may believe you should always shop for the lowest interest rate, and paying points might look like a good way to get there. However, there are a lot of factors to consider. That’s why it’s important to consult with a licensed Military Mortgage Advisor at AAFMAA Mortgage Services LLC (AMS). We can help you understand the pros and cons of paying points in your particular situation.
AMS is happy to provide an honest and fair comparison of your mortgage options. We offer a wide range of affordable mortgages designed to meet the needs of Veterans and servicemembers. Our mission is to ensure you obtain the best mortgage possible, even if it means doing business elsewhere.
Get started today. Contact a Military Mortgage Advisor at 844-422-3622 or by email at [email protected].