When applying for mortgages, you'll have some lenders give you the option to "buy down your mortgage rate" by paying a fee known as mortgage points. In exchange for paying this fee at the beginning of your mortgage, you'll enjoy a lower interest rate for the life of the loan. Read on to get the information you need to determine if paying mortgage points is right for your situation.
How much are mortgage points?
Each mortgage point is equivalent to one percent of the amount of your loan. For example, if your loan is for $150,000, one mortgage point is equal to $1,500 ($150,000 multiplied by 0.01). You have the ability to pay one mortgage point or multiple mortgage points.
The interest rate reduction that paying a single mortgage point earns varies based on the terms of your loan.
How does paying mortgage points affect your mortgage payment?
It is important to understand how paying mortgage points influences your monthly payment.
Imagine again that your loan will be for $150,000, and you plan to take out a 30-year mortgage.
Assume that by paying the fee for one mortgage point, your lender decreases your interest rate by .25 percent. If you have purchased three mortgage points, this results in a total fee of $4,500 ($150,000 multiplied by .03). The interest rate for purchasing three mortgage points is 3.5 percent. If you choose not to pay the points, the loan's interest rate is 4.25 percent.
The monthly payment for the loan with the points, is $674, while the monthly payment for the mortgage without the points is $708. However, looking at your loan's amortization after 10 years reveals that the total interest expense for the loan with the points is $46,968, while the total interest for the mortgage without the points is $55,406.
This is a difference of $8,438. After considering the $4,500 fee, your interest savings decreases to $3,938.
Now, look at the figures after you have payed the loan for 20 years. After 20 years, the interest cost for the mortgage with the points is $79,771, and the interest expense for the loan with no points is $95,169. Once you subtract the $4,500 point fee, this is a savings of $10,898.
What considerations should take into account when deciding whether or not to buy down your interest rate?
One of the most important details to take into account when deciding whether or not to pay mortgage points is how long you plan to stay in the home. As you can see from the previous calculations, the interest savings dramatically increases the longer you stay in the home.
Another component to consider is how much spare cash you have. It makes little sense to pay thousands of dollars for a one percent in your reduction in your loan's interest rate, only to have to turn around and use costly debt to finance purchases for your new home.
For more information about home loans, talk to a representative at brokers like Premium Mortgage Corp.