Mortgage Points And Down Payment Are Investments
While the case for a down payment as an investment is easy to make, most consumers might not think of mortgage points as so, yet they should. The way to measure an investment’s worth is by the return it generates for you, usually on an annual basis. When looking at a mortgage, points are an investment because they lower your future interest rate, thereby saving you money over the life of your loan. Your down payment is much the same in that it lowers your mortgage balance, reduces your monthly payment, and possibly saves you from paying for mortgage insurance.
So Points or Down Payment?
The decision between a making a larger down payment or paying for more mortgage points usually comes down to the question of how long you will remain in your new home. This is true for a few reasons:
- Higher down payments affect the early years of a loan – a higher down payment has its largest impact on your mortgage in the first few years of the loan life. During these years, most borrowers are trying to escape paying mortgage insurance, which costs 1%-2% of the loan’s value per year. A higher down payment allows you drop mortgage insurance faster and keep that money instead of giving it away. Once a borrower is no longer required to have mortgage insurance, a higher down payment will only minimally lower future monthly mortgage payments.
- Mortgage points increase in value over the life of the loan – paying for mortgage points lowers the interest rate on your mortgage, which will lower your monthly payment. The longer you hold your loan the more your monthly savings build, and the more you save.
- For most home owners the break-even point will come sometime during the 7th or 8th year of ownership. If you think you will remain in your new home for more than that amount of time, then paying for more mortgage points is probably the right decision. However, if you plan to stay for a shorter period of time, then a larger down payment makes better sense.
Cautions and Risks
A higher down payment comes with little risk. If you need to leave your home in the future, you’ll likely recoup your full down payment when you sell your home. If you bet on points paying off in the future, you need to be very secure in your employment and your finances. Otherwise you could lose everything you spent. As a borrower, you have to be aware when paying for points that, if for any reason, you must sell or refinance your home, you will not recieve any compensation for the points you bought. The fact that employment or financial situations can change quickly, and you can lose your investment in a flash, makes buying mortgage points the riskier choice. Ultimately, you have to weigh the time you plan to remain in your home along with your personal financial situation—both current and expected future—and decide what makes the most sense for you.