When applying for a mortgage, having a stellar credit score (think: 720 or higher) is the best way to land a low interest rate. But did you know that you could pay additional money at closing to get an even lower interest rate?
Before you commit to a specific loan, your lender might ask you (and if he doesn’t, inquire yourself) if you’re interested in buying points. A point is essentially a fee that is 1 percent of the loan amount. For every point you buy, your interest will generally be lowered 0.125 to 0.25 percent in return. (For example, if you are getting a 30-year $100,000, one point would cost you $1,000.) According to Bankrate, buyers can purchase typically purchase up to 3 or 4 points.
So how do you know if it’s worth it to buy points?
SKIP THEM: If you’re barely able to scrape enough funds together for the down payment, it’s best to decline your lender’s offer. Why? Purchasing points only increases the lump sum amount you must pay at closing time.
THINK ABOUT THEM: If you have some spare cash and you plan to stay in your house for at least several years, financial experts say. As long as you can afford to pay up to several thousand dollars on top of your original down payment, buying points could be a good way to reduce your total housing outlay. But you’ll need to do a bit of math.
First, calculate how much interest you’ll have to pony up each month if you don’t purchase any points. Then, figure how much interest you’ll pay monthly with the reduced interest rate you’d get by purchasing points. (Let this mortgage calculator do the work for you.)
Next, subtract the smaller payment from the larger one to figure your monthly savings. And finally, divide the expense of buying points by the amount saved. The result is the number of months you’ll need to remain the home’s owner to break even on buying points.
Provided that you plan to live in the residence for at least that long, go ahead and purchase points. But if it’s likely—or even possible—that you’ll move or pay off your entire loan before that point, take a pass.
BUY THEM: If you’ve found the home of your dreams and you can’t think of a reason that would ever make you move. Or, if you plan to take your loan’s entire lifespan to pay it off, paying upfront for points in exchange for a reduced interest rate is certainly a money move worth making.