Buying a home these days has become much more expensive. The effects of the COVID-19 pandemic spurred higher mortgage interest rates, higher rents and a scarcity of available housing.
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However, inflation is finally cooling off. As per the U.S. Bureau of Labor Statistics, current inflation hovers around 2.4%.
With lower inflation and mortgage rates finally starting to come down, buying a home has become slightly more affordable recently. However, there’s one trick that’s saving about half of homebuyers an even bigger chunk of change: buying points.
What Is Buying Points?
CNBC reported that about 49% of homebuyers today are buying points, also referred to as “discount points” or “buying down the rate,” which involves paying extra to your lender at closing to reduce the interest rate on a mortgage. In most cases, paying a fee worth 1% of your loan amount, known as a “point,” effectively reduces your interest rate by around 0.25%.
“Buying points is extremely popular today, as borrowers try to get rates closer to the historic lows of the pandemic,” Aaron Gordon, branch manager at Guild Mortgage, told CNBC.
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How To Know If Buying Points Is the Right Move
Ultimately, buying points when you initially take out a mortgage is best suited for those who know they’re staying put for the long term. Why? It usually takes about five to seven years to break even on the upfront cost savings on your monthly mortgage payments.
However, there’s one immediate benefit worth noting: As long as you itemize your deductions and the home remains your primary residence, the cost of points is tax deductible as prepaid mortgage interest. Tax deductions lower your tax liability and can potentially put you in a lower tax bracket.
2 Alternatives to Buying Points
There are two decent alternatives to save money on your mortgage payments if buying points isn’t the right move for you.
First, you could consider a 2-1 buydown, which usually costs 1% to 2% of the loan amount. With this type of agreement, the interest rate drops by 2% in the first year, 1% in the second year and then returns to the full interest rate in the third year for the remainder of the loan. Temporary buydowns are usually cheaper than shelling out cash upfront for a permanent rate deduction when you buy points.
Alternatively, you can choose to make a larger down payment instead of buying points. Putting down 20% or more will help you avoid private mortgage insurance (PMI), which can potentially cost hundreds of dollars or more per month, depending on your loan terms and credit score.
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This article originally appeared on GOBankingRates.com: Only 50% of Homebuyers Know This Secret To Lower Your Mortgage Cost
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