Finding a place to buy may be somewhat challenging when browsing through the real estate market. Particularly in terms of choosing how to get your deal financed or secure a good loan. Comprehending the many intricate financial layers of it also comes along. Mortgage points, also popularly known as discount points is frequently referred to and is probably one term that you are familiar with in this industry.
To make well-informed judgments and calculate the total cost of financing your real estate buy or agreement, it is imperative that you have a solid understanding of mortgage points and how they affect your transaction. We put emphasis on the importance of learning about the importance of mortgage or discount points before diving into the real estate market for both investors and homeowners.
What Are Mortgage Points?
Mortgage points, also popularly referred to as discount points, are one-time payments made directly to the lender at the time of closing of a real estate transaction in exchange for a lowered interest rate (the perk) on your home loan. Buying down the rate is a common term used to describe this procedure. Usually, 1% of the total loan amount, or absolute value, is charged for each mortgage point. For example, 1 point would be worth ₹20,000 on a debt of ₹20 lakh.
Mortgage points come in two varieties:
Points for Discount: These points help you by bringing down your interest rate, which further lowers your loan payments and E.M.I. thus, bringing down the collective expenditure.
Origination Points: These are non-interest-bearing costs that the lender assesses in exchange for processing the loan.
How Do Mortgage Points Operate?
You effectively keep prepaying an up front interest when you buy mortgage points in order to get a reduced interest rate over the course of your loan. For many investors and house buyers, making this initial investment proves to be a wise strategic choice and can result in significant long-term savings as well.
Over the loan tenure, this reduction in monthly payments translates into tangible savings and improved affordability.
The Effect of Mortgage Points on Real Estate Investment:
1. Lower Cost: By strategically using mortgage points, you can quickly cut the interest rate, which in turn lowers the total cost of borrowing. Long-term, it further lowers the cost of property ownership. Better cash flow and possible higher returns on investment suggest better times ahead for real estate investors.
2. Tax Benefits: Home loan borrowers may utilize this opportunity and benefit from tax deductions on both principal and interest payments. Mortgage points can at times also be eligible for tax benefits thus, reducing the effective cost of purchasing points. Section 24 of the Income Tax Act allows a deduction of up to ₹2 lakh on the interest paid on home loans for self-occupied properties, while there is no such upper limit for let-out properties.
Tax advantages for homebuyers in India with regard to home loans
i) Section 80C:
It allows a direct deduction of up to ₹1.5 lakh on the principal amount of repayment of your home loan. One can easily enjoy the perks of this, regardless of the fact, whether one has purchased mortgage points or not.
ii) Section 24:
It allows a deduction of up to ₹2 lakh on the interest paid on home loans for self-occupied properties only. Although there is no upper limit on the interest deduction for let-out properties. Again, this benefit applies irrespective of the fact whether mortgage points are purchased or not.
3. Long-term Savings: For people who are planning to remain in their home for an extended period of time, the money saved from the reduced interest rates and monthly payments can cover the initial cost of mortgage points. Over the length of a typical 20-year loan term, these savings can pile up and provide a significant financial advantage.
What should the Home Buyer do in this case?
When deciding whether to buy mortgage points in the Indian real estate market, one must consider these factors:
Loan Tenure: It must sound like an unpopular opinion or suggestion but longer loan tenures benefit more from lower interest rates which are obtained through mortgage points. So, the longer you plan to stay in the home, the more beneficial it is to buy points.
Financial Situation: Make sure you evaluate your financial stability and ability to make upfront payments without affecting other financial goals and harming your economical standing. Ensure that you have sufficient funds to cover the cost of points without having to compromise on your emergency savings or down payment.
Market Conditions: Make it a habit to monitor interest rate trends and economic conditions to gauge the potential benefits of locking in a lower rate through mortgage points. If somehow, interest rates are expected to rise, buying points could be a prudent move, in that case.
Break Even Point: Calculate the breakeven point meticulously. It is basically the time it takes for the savings from the reduced interest rate to equal the cost of the points. If you plan to sell or refinance your property (in future) before reaching the breakeven point, purchasing points may not be that beneficial for you then.
How to Calculate the Break Even Point with Ease?
Understanding the breakeven point is excessively important for making an informed and practical decision. Here is how you calculate it in the simplest way:
Firstly, Let’s Determine the Cost of Points:
To begin with, you can start by calculating the total cost of the points you are considering to purchase. If you are going to buy 2 points on a ₹40 lakh loan, the cost would be ₹80,000 which is basically 2% of ₹40 lakh.
Compute Monthly Savings: You need to figure out first, how much reduction in the interest rate will save you money, each month on your EMI. By taking into account our previous computation, your monthly savings would be approximately around ₹1,000 if the points lower your interest rate by 0.5%.
Now let’s determine the breakeven point:
You must now divide the cost of the points by the monthly savings after determining the monthly savings. We can determine how ₹80,000 / ₹1,000 equals 80 months using our numbers. This indicates that it will take an individual 80 months, or roughly 6.7 years, to recover the cost of the points.
Therefore, purchasing points would be quite beneficial if you intended to stay in the property for more than 6.7 years.
Possible Drawbacks of Mortgage Points
While purchasing mortgage points has certain obvious and immediate advantages, there are also some possible drawbacks to take into account before making your decision:
Up Front Cost: Purchasing points has an upfront cost that must be paid at transaction closure if funds are not available. This might increase one’s initial financial burden. Not all homebuyers may be able to afford this, particularly those who are already struggling to pay for their down payment and closing costs.
Liquidity Issues: Purchasing points with cash automatically lowers the amount of money available for other costs, such prospective house renovations or unforeseen emergency repairs. Just watch out that you don’t spend all of your money on point purchases.
Short-term Plans: You might not be able to pay back the points before you hit the breakeven point if you want to sell or refinance the property in the next several years. In these situations, the upfront expense could not be sufficient to offset the short-term savings, falling short of its full potential.
How to Make the Right Decision?
Deciding whether to buy mortgage points or not requires careful consideration of some factors which would include aspects like financial situation of a person, investment goals, and the ongoing market conditions at a given point of time.
Here are some ways that can help you make an informed decision on your part:
Calculate the Break Even Point Before Anything Else: Determine how long it is going to take to recoup the cost of the points by the means of monthly savings. Use easily available online calculators or just consult with your lender to get the absolute and precise figures without much hassle.
Analyze Your Cash Flow: Always ensure that you have enough funds to cover the upfront cost without compromising your financial stability. Take into immediate consideration, each and every part, big and small, of your financial plan. And it must include other investments, emergency savings, and future expenses as well.
Consult with Professionals: Speak to your mortgage lender, financial advisor, and tax professional to understand the implications of buying points. Their insights can provide help so that you have a clearer picture of whether this strategy aligns with your long-term financial goals or it doesn’t.
Conclusion:
Being aware of mortgage points is not only necessary for real estate investors, but it can also greatly benefit anyone by providing them with the advantages of cheaper monthly payments and unquestionably, long-term savings. They do, however, entail possible dangers and upfront fees. Nevertheless, you can decide whether purchasing mortgage points is the best course of action for your real estate investment or if it will not be very helpful to you by carefully evaluating your financial status and investment objectives.
At Property Souk, our mission is to help buyers and investors understand the complexities of the real estate market with ease. Whether you are purchasing your first home or adding to your portfolio of homes, our staff with expertise in various areas related to real estate are ever eager to help.
Real estate investing demands a well-thought-out plan and an in-depth understanding of crucial financial metrics. By becoming an expert in these measurements, you may guarantee your financial future and obtain the full return on your investments. Get in contact with Property Souk right now to learn more about how we can support you in your real estate investing endeavors.
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