With mortgage rates still falling to nearly historic lows, many people are buying homes, driving up demand.If you're satisfied with your current home, but want to take advantage of these incredibly low rates, you can refinance your mortgage. If you want to save even more money, you can buy points. Here's what you need to know.
WHEN YOU REFINANCE YOUR MORTGAGE, WHAT ARE POINTS?
So what are "points" when you are trying to refinance your mortgage? In reference to mortgages, "points" refers to mortgage points. There are two types of mortgage points, discount points, and origination points. However, when most people talk about "points" or "mortgage points," they're talking about discount points. Let's take a closer look at these two types of points.
What Are Discount Points?
Discount points are charges from your lender to decrease your interest rate (in other words you are buying down the rate at a certain cost). Each point costs 1% of the loan amount, so on a $125,000 loan amount, you must pay $1,250 to purchase a single point. You have the option to buy your rate down by paying points so the more points you buy the lower your rate will be. It's important to keep in mind that this can add signifcant cost to your loan so you should crunch the numbers to see how long it will take to recoup this cost in exchange for that lower rate.
What Are Origination Points?
Origination points are fees paid to the loan provider for providing the loan. This includes things like application, processing and underwriting fees, otherwise known as "Lender Fee" or "Orgination Fee."
SHOULD I BUY DISCOUNT POINTS?
Only you can decide if buying discount points is right for you. If you plan on staying in your home for several years, putting up a significant amount of cash to save a significant amount of interest over the remainder of the loan's life makes sense. If, however, you plan to sell your home in the next few years, you may be better off investing your cash in more traditional investments, like mutual funds or municipal bonds, to earn interest safely until you need to make your down payment on your next house.
Tax Considerations
If you're on the fence about buying down your interest rate when you refinance your mortgage, consider the tax benefits of prepaying your interest. Federal tax laws are constantly changing, but currently, prepaid interest is tax-deductible. Therefore, if you owed $125,000 on your mortgage, and you purchased four points for $6,000, you could add that to your itemized deductions when you file your 2020 income taxes.
If prepaying your interest will not put your deductions above the standard deduction, you should decide if you want to buy discount points by performing a break-even analysis and considering if you will keep the home long enough to, at the very least, break even.
How to Perform a Break-Even Analysis
To calculate your break-even point, divide the cost of the points you'd like to buy by the monthly payment savings. This gives you the number of months it would take to break even. If you sell your home before this point, you will have spent more purchasing the points than you saved with reduced monthly payments.
For example, you owe $125,000 on your home and purchase four points for $6,000 when you refinance your home. This results in a 1% reduction to your interest rate and it saves you $75 a month on your payment. To find how many more months you need to keep your home to break even, divide $6,000 by $75. The result is 80 months, or six years and eight months. If you plan to sell your home before this point, purchasing discount points is not worth it.
LEARN MORE ABOUT SAVING MONEY WHEN YOU REFINANCE YOUR MORTGAGE TODAY
There's never a time like the present to save money on your mortgage. For more helpful tips on how to save money while refinancing your home or answers to any other mortgage-related questions you can speak with a loan agent by clicking the "Speak to A Loan Agent" link on the Know Mortgage home page.
