What You’ll Learn
What refinance points are and how they work
The pros and cons of paying for points when you refinance
How to calculate the savings that points offer in a refinance
Refinancing a home loan can offer several benefits—from locking in a lower interest rate and reducing your monthly mortgage payment, to paying off your home loan sooner, or even cashing out on some of the equity you’ve built.
If you’re considering a loan refinance and can’t find an interest rate competitive enough to make the process worthwhile, then paying for discount points might help you reach your financial goals.
What are points when refinancing?
Mortgage points are upfront fees paid directly to your lender at closing in exchange for a lower interest rate.
A lower interest rate reduces your total monthly payment and can save you a significant amount of money over the life of your loan.
When you refinance a loan, you’re basically swapping out your original mortgage for a new one. In the process, the old loan gets paid off and you agree to the terms of the new one. Just like with a regular mortgage, you might want to consider purchasing points at closing as a way to “buy down” the interest rate of your new refinance mortgage. You can also use points to secure various types of more favorable loan terms.
How do mortgage refinance points work?
In short, points are fees. Each point costs about 1% of the corresponding loan’s total amount—the more expensive the loan, the higher the cost of each individual point.
Typically, for each point purchased, you would receive a 0.25% reduction in your interest rate. If you don’t want to purchase an entire point, you can purchase fractions of a point to buy down your rate. Keep in mind that most lenders have a cap on the number of points you can buy.
Let’s look at an example of how mortgage refinance points work in action:
Meet Jamie. Jamie is refinancing his home and taking out a new loan of $300,000. Based on his new loan amount, Jamie will have to pay $3,000 per refinance point. Purchasing 2 points will raise his closing costs by $6,000 and lower his rate by 0.5%. In this scenario, his original interest rate of 4% would come down to 3.5%, and his mortgage payments would go from $1,432 to $1,347 per month, saving him $1,020 over the course of the year.
Let’s say Jamie decides to pay for 2.5 points. The extra .5 point adds $1,500 to his closing costs ($7,500 in total points purchased) and decreases his interest rate by a total of 0.625% (note that actual buydown percentages are determined at closing based on market rates). By purchasing an additional half-point, he can save an extra $240 a year in interest. But is that extra savings worth the additional upfront cost?
Deducting points on refinance: Examples
Now that you understand how to purchase points and the impact they can have on your monthly mortgage payment, should you actually consider purchasing them when you refinance? It all comes down to how long you plan on staying in your home.
Here are a couple of scenarios to consider.
Scenario 1 - “Purchasing points when you plan to stay put”
Santiago loves his home and doesn't plan on leaving anytime soon. When he originally bought this house, he couldn’t afford to make a 20% down payment. As a result, he didn’t qualify for a very competitive interest rate.
Over time, he’s been able to build up his savings and now has enough money to lower the interest rate with points when he refinances.
Let’s say that the upfront fees for purchasing points cost Santiago $2,500, and he buys down to an interest rate that nets a monthly savings of $130 per month. In this scenario, it will take him less than 2 years to recoup the initial cost of purchasing points. Knowing that he plans to live in his home long enough to enjoy the associated savings, it makes sense for Santiago to refinance.
Scenario 2 - “Purchasing points when you plan to sell”
Nancy loves flipping houses. She tends to purchase a home, give it a little TLC, and then sell. She’s taking a cash-out refinance on her most recent flip to consolidate some of her renovation bills.
(A cash-out refinance allows homeowners to tap into their home equity by getting a new mortgage for more than they owe on their home.) In Nancy’s case, she’s not ready to move just yet but she knows she’ll be putting her home up for sale sooner rather than later. Because of the time it takes to see savings after purchasing points, Nancy decides to pay her regular closing costs during the refi and keep more cash in her pocket.
What to consider before paying points on a refinance
If you’re wondering whether it’s worth paying points when refinancing your mortgage, here are some of the most important factors to consider:
- Purchasing points increases your upfront costs. There’s no getting around that. But if you can financially swing it, and you plan on staying in your home for long enough, you can save thousands of dollars in interest over the life of your loan.
- If you’re not planning on staying in your home after a refinance, you likely won’t save any money by purchasing points. You may want to consider taking credits instead, which can help you save on closing costs in exchange for slightly higher monthly payments.
- It’s all about the break-even point. If you don’t plan to live in your home long enough to offset the initial cost of purchasing point, it’s not sensible to buy down your rate because the monthly savings won’t have time to accumulate and outweigh that upfront investment.
- Points are almost always an option when refinancing. If you’re considering refinancing with points, do the math (try our refinancing calculator and consider any other options for saving on your mortgage loan.
A point well taken
Mortgage refinance points can be an effective way to reduce the interest rate on your refinance and save a substantial amount of money t over the course of a loan. If you’re thinking about refinancing, see what kinds of rates and options are available with your lender.
At Better Mortgage, you can get pre-approved in as little as 3 minutes.