Mortgage points, also known as discount points, are fees paid to a lender at the closing of a mortgage loan in exchange for a reduced interest rate. The reduced interest rate means a smaller monthly payment and less overall interest paid over the life of the loan. A "point" is equal to 1% of the mortgage but can also be expressed as "100 basis points" which is a smaller unit of measurement for points.
Here's how mortgage points work:
For example, on a $200,000 mortgage, 1 point, or 100 basis points, would cost $2,000 (1% of $200,000). Lenders may offer the option to buy fractions of a point as well which would be any amount less than 100 basis points e.g. 50 basis points or 25 basis points.
Savings: The reduced interest rate can lead to long-term savings on your mortgage. By paying points upfront, you can potentially save money over the life of the loan, especially if you plan to stay in the home for a long time. Be sure that the "break-even" period is in line with your plans.
Break-even point: To determine if paying points is beneficial, you need to calculate the "break-even point." This is the point at which you recoup the initial point cost through the additional savings provided by the lower interest rate (compared to the interest rate option that does not contain points). The way to calculate this is by dividing the cost of the points by monthly savings it provides i.e. point cost ÷ savings = break even point (represented in months)
Using the example above on a $200,000 mortgage, lets say the discount point provides a savings of $43/mo. To determine the break even point, we would:
$2,000 (point cost) ÷ $43 (savings provided by the lower rate option) =46.51mo or 3.87yrs
In this case, the purchaser would not begin to experience true savings until about 3.87years.
Tax implications: In some cases, mortgage points may be tax-deductible. You should consult with a tax advisor or accountant to understand the specific tax implications based on your situation.
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