Why Buying Points on a High-Interest Rate Mortgage Could Be Your Golden Ticket
Hey there aspiring homeowners!
If you’re standing at the threshold of buying your first home and the current high-interest rate environment has you doing double takes, don’t worry. In today’s post, I plan to demystify the often-underestimated strategy of buying mortgage points and how this can help you lower your monthly payment if you are buying a home today.
First things first, if you haven’t heard of "buying mortgage points," you’re not alone! This used to be more common practice in the past when interest rates were higher than the blissful low rates we’ve become used to.
So, let’s get into it!
1. What are Mortgage Points?
Mortgage points, also known as discount points, are essentially a fee you pay to your lender at closing in exchange for a reduced interest rate. Think of it as a trade-off: a higher upfront cost for lower monthly payments throughout the life of your loan.
The cost of each mortgage point is 1% of the loan amount and will reduce the loan’s interest percentage by .25%.
Buying mortgage points is a strategy that was offered by banks to savvy homebuyers as an incentive to drive increased down payments. This old strategy can definitely be useful in today’s financial ecosystem, as rates are higher now, and buying points upfront can reduce the overall cost of the loan and reduce your monthly payment until you refinance.
2. Why Would Anyone Buy Points?
In periods of high interest, the savings from a reduced rate can be substantial over the life of your loan. Buying points becomes particularly enticing if you plan to stay in the home for a long time. The longer you stay, the more you save!
So if you’re a home buyer in the scenario of determining whether you should put more cash down upfront (aside from securing the offer!) or save cash for enhancements/repairs, it may be worth considering purchasing some mortgage points to lower your overall cashflow impact.
3. Let’s Talk Numbers: Comparing Two $700k Mortgages Side by Side
Imagine two neighbors, Alex and Michael. Both borrow $700k for their homes, but Alex decides to buy two points (.50% interest rate discount), while Michael opts for the standard rate.
Scenario A: Alex Buys Two Points
Loan Amount: $700,000
Standard Interest Rate: 7%
Cost of each Point: 1% of the loan amount ($7,000)
Total Cost for Two Points: $14,000
Reduced Interest Rate after Buying Two Points: 6.5%
Scenario B: Michael Goes with the Standard Rate
Loan Amount: $700,000
Interest Rate: 7%
Now, using a standard 30-year fixed mortgage calculator: Alex’s monthly payment at 6.5% is roughly $4,429.91, and Michael’s monthly payment at 7% is about $4,658.11.
The difference is $228.20 per month, which may not seem like much in the short run. Over 30 years, that’s a saving of $82,152! Even after subtracting the initial $14,000 Alex spent on points, he's still ahead by $68,152. That’s assuming interest rates never come down and there isn’t any opportunity to refinance sooner.
With these savings, Alex might be sipping some fancy cocktails on a tropical island at least once a year!
4. Factors to Consider
Like all financial strategies, this is not a one-size-fits-all solution and there are some factors that would determine whether this strategy works for your circumstances:
Your available cash at closing. Buying points means higher upfront costs. Ensure you still have enough for other closing costs, a down payment, and an emergency fund before you sink all of your reserves into buying down your interest rate.
How long you plan to stay in the home. If you’re the nomadic type and plan to move in a few years, buying points may not be the best option. Instead, it may be better to look for an Adjustable-rate mortgage with lower interest for the first several years. But if you're planting roots, then it’s worth considering.
Current interest rates and loan amount. When rates are high, the potential long-term savings from buying points can be substantial. This effect is compounded for larger loan amounts. That being said, the interest savings on a low loan amount compared to sunk cost into buying down points may not be a great tradeoff.
5. Closing Thoughts
Buying Mortgage points might sound as fun as a math test on a Monday morning, but the potential savings, especially in high-interest climates, are no joke! Like any financial decision, it's essential to analyze your personal circumstances and long-term plans.
If your head’s spinning from all these numbers, or you're wondering how this strategy might apply to your unique scenario — it's time for our call to action!
Reach out to your trusted local agent (that’s me!) for a personalized consultation. Let’s chart out the best course for your homeownership journey. Remember, while interest rates might be out of our control, how we navigate them is very much in our hands.
Happy home buying!
— Harold Eli
