What Are Mortgage Points?

Before purchasing a home, buyers should understand how mortgage points will affect their interest rate, their monthly payment, and the overall cost of the loan. What are mortgage points? Sometimes called discount points, they provide buyers with a lower interest rate on a mortgage in exchange for a one-time fee at settlement. When shopping for a loan, ask your lender to provide an official Loan Estimate for a mortgage with points and one without so you can compare actual numbers when making a final decision.

Cost and Value of Mortgage Points

To determine whether purchasing points is worthwhile for your specific loan, you must calculate the break-even point of your loan. Ask your lender how much you will save in monthly interest by purchasing points. Divide the cost of points by that amount to get the number of months it will take to break even. Using the example above, let's say that you will save $150 a month by purchasing points. Divide $6,000 by $150 to get a break-even point of 40 months. If you plan to stay in the home longer than a few years, buying points is likely worth the money in this instance. If you think you may refinance your loan or sell the house in fewer than 40 months, however, use that money to increase your down payment or put it toward closing costs.

Purchasing Points vs. Increasing Down Payment

If you are not planning to pay 20% down on your mortgage loan, you must factor the cost of private mortgage insurance (PMI) into the above calculations. PMI is a premium paid along with your monthly mortgage payment until you reach 20% equity on the home. Let's return to the example above. If you are only putting down 10% on the loan ($30,000) and your required PMI costs about $150 a month, that would cancel out the savings associated with buying points.

Work with your lender to determine when you can expect to reach 20% equity and compare that number to the break-even point to decide whether or not it makes more sense to increase your down payment instead of buying down your interest rate. You should also compare the costs of a 30-year fixed-rate loan with points to a 15-year fixed-rate loan without points.

Tax Implications of Mortgage Points

The interest paid on a mortgage for a primary home can be deducted on your tax return, but are mortgage points deductible as well? If you are buying a home that will serve as your residence or a second home to rent out as an investment, you can deduct mortgage points if you paid the lender directly for the points rather than rolling the cost of the points into the mortgage. For tax years 2018 to 2025, the deduction is only valid for the first $750,000 of a home loan.

Keep in mind that you may be required to spread out the deduction over the life of the loan instead of taking it all in the year in which you purchase the home. Consult a tax professional for details about your situation.

When you're shopping for a home loan, consult the team at Blackhawk Bank for answers to all your questions about purchasing points. We'll be happy to help you find the best mortgage for your needs.

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