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This Strategy Could Lower Your Mortgage Payments

·7 min read
SmartAsset: What Are Mortgage Refinance Points?
SmartAsset: What Are Mortgage Refinance Points?

Mortgage points are fees you pay to help reduce the cost of buying a home. When you agree to pay points your lender can reduce your mortgage interest rate, which can save you money and potentially lower your monthly payment. If you already have a mortgage and plan to refinance, you may be offered the option to purchase refinance points. Whether it makes sense to pay points when refinancing a mortgage can depend on your financial situation and reasons for taking out a new loan.

A financial advisor could help you create a financial plan for your home buying needs and goals.

What Are Points in Refinancing?

Refinance points or refinancing points are fees you pay to the lender at closing in exchange for some type of financial benefit or as a condition of getting a loan. Whether you’re buying a home for the first time or refinancing an existing mortgage, one point is typically equal to one percent of the loan amount. So if you’re refinancing a $300,000 mortgage loan, one refinance point equals $3,000.

That doesn’t mean buying a point would reduce your mortgage rate by 1%, however. Instead, points most often reduce your rate by 0.25% apiece, though the actual reduction value can vary by lender. This rate discount applies for the entirety of the loan, assuming you choose a fixed-rate loan. So if mortgage rates are at 3.50%, buying one point might bring your rate down to 3.25% instead.

How Do Refinance Points Work?

Generally, when you’re talking about mortgage points it’s in the context of using them to reduce your interest rate. Using mortgage points this way is called “buying down” the rate. In effect, you’re paying more money to the lender upfront to reduce your mortgage costs over the long term. This type of refinance point or mortgage is called a discount point.

It’s possible, however, to use refinance points for other purposes. For example, mortgage points can also be paid to the lender to originate the loan. In that case, they’re referred to as origination points. The exchange rate is still the same for origination points: one point is equal to one percent of the mortgage amount.

Paying origination points won’t do anything to lower the interest rate on your loan. They’re simply a fee the lender charges for making the loan in the first place. If a lender offers you a refinance mortgage with no origination points, be sure to read the fine print. They might make up for the lack of origination fees with a higher rate, in which case you may want to purchase discount points to bring the rate down.

In the case of refinancing an existing home loan, you may be able to use refinance points to escape a prepayment penalty. Prepayment penalties require you to pay the lender extra money if you pay your mortgage off early, to compensate them for lost interest. You may also be able to use refinance points to secure more favorable terms for a home loan.

Do You Have to Pay Points When Refinancing?

SmartAsset: What Are Mortgage Refinance Points?
SmartAsset: What Are Mortgage Refinance Points?

You’re not obligated to purchase refinance points when taking out a new home loan to pay off your existing one. But it’s important to consider whether paying refinance points makes sense, especially if you’re hoping to get the best deal possible on a mortgage.

The first question to consider is how long you plan to stay in the home. If there’s a move on the horizon relatively soon, paying refinance points may not make sense since you might not reach the break-even point. The break-even point on mortgage points is when you recoup the money you spent upfront in interest savings. Depending on the terms of the refinance loan, it may take five years or longer to reach the break-even point.

It’s also important to look at how many points you’re willing to pay to reduce your refinance rate. The more points you purchase, the more you’ll trim off the rate and the bigger your savings on interest. But again, this may not be as valuable to you if you don’t plan to stay in the home for the majority or entirety of the loan term.

Your purpose for refinancing may also come into play. Some people refinance to get a better rate; others refinance to move from an adjustable-rate mortgage (ARM) to a fixed-rate loan. And still others are interested in refinancing to cash out some of their home equity. If you’re contemplating paying refinance points, it’s helpful to weigh where that fits into your overall refinancing goals.

Can You Deduct Refinance Points on Your Taxes?

The IRS allows homeowners to claim a tax deduction for mortgage points when certain conditions are met. You’ll need to itemize in order to deduct mortgage points and mortgage interest. Comparing the tax benefit of itemizing versus claiming the standard deduction can help you see which one yields more savings.

Points can be deducted over the life of the loan or in the year they were paid. To deduct points in full the year you pay them when refinancing an existing mortgage, you have to meet these requirements:

  • The loan must be secured by your main home

  • Paying points must be an established business practice in the area where the loan was made

  • Points can’t be an unreasonable amount, based on what’s typically charged in that area

  • You use the cash method of accounting when filing tax returns

  • Points weren’t paid for items that are listed separately on the settlement sheet (such as appraisal fees or inspection fees)

  • Funds provided at or before closing were at least as much as the points charged

If you qualify to deduct refinance points, then buying them could be a good move. Again, though, this assumes you plan to stay in the home even after reaching the break-even point. Talking to your financial advisor or a tax expert can help you to decide if buying refinance points makes sense from a tax perspective.

Bottom Line

SmartAsset: What Are Mortgage Refinance Points?
SmartAsset: What Are Mortgage Refinance Points?

Whether buying refinance points is worth it or not to you can depend on your financial situation and what you hope to achieve by refinancing a home loan. Remember that points are negotiable, just like anything else, so if you’re not satisfied with what your lender is offering don’t be afraid to ask for a better deal. Also, keep in mind that once you’ve closed on a refinance loan buying points is off the table so you’ll need to make up your mind beforehand whether you want to purchase them or not.

Mortgage Planning Tips

  • Consider talking to your financial advisor about whether purchasing refinance points could be the right move when seeking a new home loan. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • One of the most important steps in the refinancing process is comparing loan options. The interest rates and loan terms you might qualify for with one lender might be very different from what you could get with another. Taking time to shop around for mortgage refinancing loans and review the credit score and income requirements can help you find a lender that fits your needs and situation.

Photo credit: ©iStock.com/South_agency, ©iStock.com/Andrii Dodonov, ©iStock.com/wichayada suwanachun

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