When It Makes Financial Sense to Pay Points on a Mortgage

Deciding whether to pay mortgage points to buy down your interest rate is a critical financial decision that should be carefully considered based on various factors such as your long-term plans and the break-even point.

Understanding Mortgage Points

Mortgage points, also known as discount points, are prepaid interest that can reduce your monthly mortgage rate and subsequent payments. Each point typically equates to one percent of the loan amount. Paying points can lower your mortgage rate, which in turn reduces the total amount of interest you pay over the life of the loan.

The Conditions Under Which Paying Points Makes Sense

Paying for points is a complex decision. It makes sense when the rate you receive as a 'buy down' is utilized for a period greater than the normal rate you qualified for when applying for the loan. Specifically, if you plan to stay in the home for longer periods (e.g., more than five years), it can be a smart long-term move.

Factors to Consider

Length of Ownership: Generally, paying points is most beneficial if you plan to stay in the home for at least five years or more. Short-term thinking that lasts less than five years is unlikely to yield significant savings due to the upfront costs of points. Break-Even Point: The break-even point is the period in which the savings from lower monthly payments cover the cost of the points. If you plan to stay in the home longer than this, it could be a financial smart move. Easier Qualification for Additional Loans: Lower monthly payments resulting from paying points can make it easier to qualify for additional loans in the future, such as a second home or an investment property. Even though the initial savings are modest, the lower payments can improve your debt-to-income ratio, making you a more attractive candidate for future loans.

Alternative Strategies for Paying Down Your Mortgage Faster

There are many ways to accelerate your mortgage repayment beyond paying points, such as:

Equity Optimization: This strategy involves using home equity to fund investments that yield higher returns than the interest on your mortgage. Velocity Banking: This involves setting aside a portion of your income to build a buffer, which can be used to make extra principal payments on your mortgage. Infinite Banking Concept: This strategy involves using cash value life insurance as a financial tool to pay down your mortgage and other obligations while providing a safety net for your family.

Finding the Best Financial Review for the Decision

To determine if paying points makes sense, compare the monthly savings from lower interest rates with the upfront cost of the points. Divide the monthly savings by the cost of the points. A break-even point between two and three years can be seen as a smart financial move, especially if you intend to be in the home for a long period (five years or more).

The Bottom Line

While paying points can save you money in the long run, it is not a one-size-fits-all solution. It is crucial to evaluate your personal financial situation, long-term plans, and the break-even point to make an informed decision. Whether you decide to pay points or explore alternative strategies, the key is to act in a way that aligns with your financial goals and reduces your overall mortgage repayment time.