Are you looking to lower the interest cost associated with your mortgage? Have you ever heard of buying a discount on your mortgage rate?
It is typical for most Canadians to spend their lives making a place where they can live, raise their families, and call it home. This is the reason over 5.71 billion Canadians spend around $100 billion every year on mortgage payments, with approximately 33% of it in interest costs.
Mortgage loan points can help you save this interest cost, provided you do it smartly. Let us understand this concept.
What Do You Mean by Mortgage Loan Points in Simple Language?
You can understand mortgage loan points as an interest rate discount available from the lender. The homeowners who have a mortgage can buy these mortgage loan points to reduce your contracted mortgage rate.
One mortgage point:
- It has the capacity to reduce your mortgage rate by 0.25%
- It costs 1% of your mortgage amount
If you have taken a mortgage of $500,000 at an interest rate of 5.50%, then you can buy one mortgage point for $5,000 (1% of $500,000) and your interest rate will fall to 5.25% (5.50% – 0.25%).
Similarly, if you wish to buy two mortgage points, then:
- It will reduce your mortgage rate by 0.50% (0.25% * 2)
- It will cost you 2% of the mortgage loan amount (1% * 2)
In continuation of the above example,
If you wish to buy two mortgage points, then you will be required to pay a sum of $10,000 (2% of $500, 000) and your interest rate will now fall to 5% (5.50% – 0.25% – 0.25%).
Can You Buy Half Mortgage Loan Points?
The answer is YES. You can certainly buy half mortgage points, but by doing so, the benefits will also reduce by half.
One mortgage point lowers your interest rate by 0.25%, hence, when you buy a half mortgage point then it will reduce your interest by 0.125% (0.25%/2).
Similarly, the expense incurred in buying the loan mortgage point will also reduce by half. Now, you will be required to pay 0.5% (1%/2) of your mortgage loan amount to scoop up half of a mortgage point.
When Will You Be Charged for The Cost Associated with Buying the Mortgage Loan Points?
They commonly refer mortgage points to “buying down the mortgage rate” and are paid upfront to your mortgage lender.
The costs associated with buying them are usually a part of the closing costs, including diverse types of expenses, such as application fee, attorney fee, closing fee, credit report fee, etc.
Hence, if you have surplus cash and can afford to buy the mortgage points by paying the down payments and other closing costs, they can help you save hundreds of dollars in interest costs.
Is the Cost Associated with Buying the Mortgage Loan Points Tax Deductible?
The answer is YES. The upfront payments on mortgage loan points are a tax-deductible expense and can reduce your taxable income.
Thus, mortgage loan points provide you with dual benefits of:
- Saving taxes
- Lowering your mortgage interest rate
What Is the Difference Between Origination Points and Discount Points?
Most new home buyers often get confused between these two terms and consider them like each other. However, this is not true.
Typically, one can divide the mortgage points into two different classes, which are:
First things first, the origination points do not lower your interest rate. These are just the costs charged to you by your lender for processing, reviewing, and approving your mortgage loan application. We also know these as application fees and vary from lender to lender.
Various mortgage loan points enable you to lower your interest rate by a fixed percentage. One discount point will reduce your interest rate by 0.25% and cost you 1% of the mortgage loan amount.
The benefits and costs associated with the discount points are standard and do not vary from lender to lender.
How to Do a Cost-Benefit Analysis regarding Mortgage Loan Points? Explain Me with An Example.
Let us take the example of Alex. He is a young Canadian buyer and has shortlisted a house in the Greater Toronto Area.
After working out with a leading lender, he has secured a mortgage loan of $375,000 for a 5-year term at an interest rate of 5%. Alex will pay 20% of the purchase price in down payment, which comes out to be $75,000 and 15% in income tax.
Further, he intends to buy three loan mortgage points as his lender’s executive advised. But he took financial advice on the matter, and his financial advisor gave him the following presentation:
|Particulars||Scenario I||Scenario II|
|Mortgage Loan (Principal amount after deducting down payment)||$300,000||$300,000|
|Mortgage Loan points||Yes, 3 points purchased||No|
|Interest rate||4.25% (5% – 0.75%)||5%|
|Purchase cost of mortgage loan points||$9,000 (3% of % $300, 000)||NIL|
|Total Interest paid||$33,532||$39,682|
One can observe from the table above that Mr. X enjoys savings of:
- $6,150 ($39, 682 – $33, 532) in interest cost
- $1,350 (15% * $9,000) in tax savings
He paid $9,000 upfront in buying the mortgage loan points.
This led to a negative net saving of $1,500 ($6,150 + $1,350 – $9,000).