How to calculate mortgage points
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Introduction:
Mortgage points, also known as discount points, are an optional upfront fee paid by homebuyers in order to obtain a lower mortgage interest rate. By paying a higher fee upfront, borrowers can save money on their monthly mortgage payments and overall loan costs. In this article, we will explore how to calculate mortgage points and assess whether they are a financially sound option for your specific situation.
Step 1: Understand Mortgage Points and Their Purpose
Mortgage points are expressed as a percentage of the total loan amount. Typically, one point equals 1% of your loan amount. For example, if you have a $300,000 loan, one point would cost $3,000. The more points you buy, the lower your interest rate will be. It is essential to consider that not all lenders offer the option to purchase points, so it’s crucial to discuss this matter with your lender beforehand.
Step 2: Determine the Interest Rate Reduction
Each point you purchase will result in a specific interest rate reduction. This can vary depending on your lender but usually ranges between 0.125% to 0.25% per point. Thus, purchasing two points on a $300,000 loan with an interest rate of 5% (0.25% reduction per point) would lower the interest rate to 4.5%.
Step 3: Calculate Your Monthly Savings
To determine the monthly savings achieved by purchasing mortgage points, you have to calculate your monthly mortgage payments at both the original and reduced interest rates.
Using an online mortgage calculator or spreadsheet software can help you perform these calculations quickly and accurately.
For example:
Original interest rate (5%) monthly payment = $1,610
Reduced interest rate (4.5%) monthly payment = $1,520
Monthly savings = $1,610 – $1,520 = $90
Step 4: Calculate the Breakeven Point
The breakeven point is the moment when your savings on monthly payments equals the upfront cost of mortgage points. To determine your breakeven point, you have to divide the cost of points by the monthly savings.
Using our example:
Breakeven Point = ($3,000 per point * 2 points) / $90 monthly savings = 66.67 months or approximately 5.5 years
Step 5: Assess Your Financial Situation and Long-Term Plans
Now that you have calculated your breakeven point, it’s time to assess whether purchasing mortgage points is a good decision for you. A critical factor to consider is how long you plan to live in your home or keep the mortgage. If it’s longer than the breakeven point, purchasing points might be beneficial.
Additionally, before making a decision, evaluate your financial situation and short-term needs. If you have spare cash and can afford the upfront cost of points without sacrificing essential expenses like an emergency fund or retirement contributions, mortgage points might be a worthwhile investment for long-term savings.
Conclusion:
Calculating mortgage points is not a complicated process but requires in-depth analysis of your financial goals and living plans. By understanding how mortgage points work and calculating their potential benefits using the steps outlined above, you can make an informed decision about whether this option is suitable for your unique situation.