Refinance points are a confusing concept to many homeowners looking to refinance. It’s also important to note that buying points is not for every homeowner. It’s true that mortgage refinancing points can be used to produce more favorable terms for your new home loan, but only certain circumstances will apply.
In order to capitalize on refinance points, you must first educate yourself about what refinance mortgage points are and how they are used; the following information can help. As a result, you should see that with a bit of basic math, you can determine if you will benefit from purchasing points.
Though refinance points may seem confusing, with simple math, many homeowners can easily see if points will benefit them. (Photo/Pixabay)
What are refinancing points?
In short, points are fees paid directly to the lender at closing in exchange for a reduced interest rate,or to cover the fees of creating the loan. Typically, a single refinancing point is equivalent to one percent of the total amount of a new home loan.
For example. if your new loan will be for $200,000, then, one point would equal $2,000.
Points on a mortgage refinance can be used in a number of different ways. Sometimes, they are mandatory; a lender requires a borrower to pay a certain number of points at closing. Other times, they are voluntary and may be used to secure more favorable loan terms – in this instance, they are called “buying down the rate,” which can, in turn, lower your monthly mortgage payments.
Most credible lenders, especially those offering 30-year fixed refinance mortgages, will provide the opportunity to points. How can you use them?
How mortgage refinance points are used
Refinancing points can be used in several different ways, including:
Discount points – You can sometimes “buy down” the interest rate on your home loan by paying points at closing. For every point that you pay, for instance, your interest rate may be reduced by a quarter of one percent. It’s common to buy 0 to 4 points. This up-front purchase is tax-deductible, which can mean additional savings for the borrower.
Eliminate prepayment penalty – Many mortgage loans include restrictions on early payoffs or buyouts. If you pay off your loan early, you could face stiff fees. Sometimes, refi points can be used to get rid of that penalty.
To secure other terms – There is a wide range of home loan products out there. Mortgage refinance points can be used to secure various types of favorable terms. A willingness to pay points upfront can have huge benefits in the long run.
Origination fee – Usually, this fee is charged by the lender to cover the costs of making the loan. As with the discount points, the origination fee should be tax-deductible. The IRS has specific language surrounding origination fees, so you need to ensure these points were used to obtain the mortgage rather than covering ancillary closing costs.
Should you pay mortgage refinancing points or not?
Many people struggle with the decision to pay refinancing points. Most of the time, it’s only beneficial to pay those points when you plan on staying in your home for quite a while. This is particularly true if you’re paying points to buy down your interest rate. The short-term incentive can blind long term reality.
One thing to notice is how much you’ll save over the long term. How many points to refinance is usually up to you; obviously, though, the more points you pay, the more you will save over the span of a 30-year mortgage loan.
Another factor to consider is how expensive the upfront cost will be. Calculate your break-even point, or how long it will take you to pay off the upfront cost of the points.
For example, if you bought one point for $2,000 lower your interest rate 0.25 percent, you could expect a monthly savings of $30.55. To find your break-even point, you’d divide your upfront cost, $2,000 by your monthly savings, $30.55. The result of this equation will show you, in months, how long it would take to break even from buying this point. In this case, 65.4 months, or about 1/5 of a 30-year mortgage.
Also, consider tax breaks you might earn. By pre-paying the interest for the life of your loan, and at a discounted rate, you can likely deduct them from your taxes.
With this in mind, buying points to lower your rate makes the most sense for home buyers refinancing with a fixed-rate mortgage and if they plan on owning the home after they have reached the break-even period. Most other refinancing circumstances would be more expensive for a borrower. But, everyone’s situation is different. Do the math to see if points could help you.
Final thoughts on refinancing points
As with all things mortgage, it’s best to arm yourself with as much knowledge as possible. Determining the best strategy for your home savings requires personal assessment. You know your current and future finance goals better than anyone. If you need help laying out your options, and determining which are the right questions to ask, speak with a mortgage broker or a lender.
As professionals in the field, they will be able to provide you with more information and help steer you in the right financial decision.