Here’s When You Should (and Shouldn’t) Buy Mortgage Scores

Even if the market isn’t hurting potential buyers, buying a home is never an easy task. There are a lot of decisions to make when you get a mortgage, and for a first-time home buyer , paying off mortgage points can be especially confusing.

Mortgage points are fees a borrower pays to lower the interest rate on a loan. This is sometimes called “rate shopping” because it reduces the total amount of interest the borrower pays over the life of the mortgage. In other words, you can think of mortgage points as prepaid interest. So, when does prepaying interest like this make sense? Here’s a basic overview of how mortgage points work, and how you pay them off might be the right move for you.

What are mortgage points?

Mortgage points, sometimes called discount points, are prepaid interest you pay to lower your interest rate. Each point is usually equal to 1% of your mortgage amount. For example, let’s say you take out a $200,000 mortgage with an interest rate of 4.5%. If you pay one point equal to $2,000, the lender can reduce your rate to 4.25%. This may not seem like much at first, but that quarter of a percentage point can save you thousands of dollars in interest payments over the years. However, you will have to pay the points up front when you close on the house.

So how do you weigh the benefit of paying interest against the upfront cost of the mortgage points? Let’s take a look.

When should I pay mortgage points?

Paying for points may be worth it if you plan to stay in your home for a long time. Here are some scenarios where paying with points can be beneficial:

• You plan to keep your mortgage for several years. If you stay in your home long enough to recoup the upfront cost through interest savings, the points may be worthwhile.
• You can afford the initial cost. The points can be worth between 1% and 3% of your mortgage amount. Make sure you have funds available at closing to cover all costs without overburdening your finances.
• You need to lower your monthly payment. Paying points lowers your interest rate, which lowers your monthly mortgage payments. This can help you qualify for a mortgage you might not otherwise be able to afford.

When to think twice about paying out points

Here are some cases where paying points may not be beneficial:

• You are planning to move soon. If you don’t stay long enough to recoup the initial cost of points through interest savings, it won’t be worth it. Don’t pay points if you can move in the next one to three years.
• You have limited funds to close. If paying points would strain your budget for other closing or moving costs, it may be smarter to skip the points and leave more money in your pocket.
• You can get a low rate without points. Compare your options to see if you can get a competitive price without buying points. In this case, payment of points may not be required.

Do the math and talk to your lender

If you have the cash and plan to stay in your home for a long time, it’s worth considering points to “buy the price.” If you’re in doubt, you can use a points calculator to determine how much benefit you’ll get from paying points.

Ultimately, the best way to decide whether paying points makes sense is to discuss your situation with your mortgage lenders. They may provide bet quotes with and without points so you can compare your options. Run the numbers to see if the points you earn will pay off in the long run.