Most of us will spend the most money on a house when we buy it, so anything that can lower the cost of a mortgage is worth looking into. Some homebuyers buy mortgage points in addition to getting a good price and looking for the best mortgage rates.
So, what are the points of a mortgage? They can also be called “discount points,” and all they do is lower your interest rate for a fee.
Let’s take a closer look at what mortgage points are, how they work, and when it’s a good idea to use them.
What are mortgage points?
Mortgage points are the fees that a borrower pays to a mortgage lender to lower the interest rate on the loan. This lowers the total amount of interest that the borrower pays over the life of the mortgage. This is sometimes referred to as “buying down the rate.”
Each point a client buys costs 1 percent of the total amount of the mortgage. So, a $300,000 debt with one point would cost $3,000.
In reality, mortgage points are a type of interest that is paid ahead of time. By getting these points, you can lower your loan’s interest rate by 0.25 percent per point, on average. You can usually buy as little as a part of a point or as many as three whole points.
By lowering the interest rate on the loan, you can lower the amount you have to pay each month. But keep in mind that you have to pay for this upfront. Most of the time, the longer you plan to live in a home, the more points will help you. Use this tool to get an idea of how much the points on your mortgage rate could save you.
Origination points vs. discount points
“Discount points,” which are a type of mortgage point that lowers your interest rate, should not be confused with “origination points,” which are a different type of mortgage point.
Origination points don’t change your loan’s interest rate, and you have to pay them whether you want to or not. Fees are what a lender charges to start, review, and process your loan. One purchase point is usually equal to 1% of the total debt, just like a discount point. So, if a lender charges 1.5 starting points on a $250,000 mortgage, the borrower has to pay $4,125. Most of the time, you pay your loan points along with your closing costs when you buy a home.
Not all mortgage companies charge startup points. Some lenders let borrowers get loans with no or cheap closing costs or transaction points. However, they often make up for this by charging higher interest rates or other fees.
What are points and how do they work?
Usually, each mortgage discount point drops your loan’s interest rate by 0.25 percent. For example, if your mortgage rate is 4%, one point would lower it to 3.75 % for the life of the loan. How much each point brings down the rate, though, changes by provider. The ability of mortgage points to lower rates also relies on the type of mortgage loan and where interest rates are in general. When you talk to mortgage lenders about buying points, they should give you all the facts.
Borrowers can buy more than one point and even parts of a point. For example, a half-point would cost $1,500 on a $300,000 mortgage and lower the rate by about 0.125 percent.
The points are paid at closing and are listed on the loan estimate, which buyers get after they apply for a mortgage, and the closing statement, which they get before the loan closes.
Should you buy mortgage points?
By paying for mortgage points up front, you can lower the total cost of your loan and your monthly payment. There are a few times when it makes the most sense:
If you’re going to live there for a long time. Because getting points on a mortgage loan lowers the rate for the life of the loan, every dollar you spend on points goes further the longer you pay that mortgage. So, if you plan to stay in the house for a while, the money you’ll save each month will probably make up for the cost of installing solar panels. If you don’t plan to live in a house for a long time, paying points is probably going to cost you money in the long run.
You already have a 20% down payment. If so, you’re avoiding private mortgage insurance (PMI) and probably getting the best interest rate the loan can give you. Even if you haven’t reached 20% on the down payment, putting money there instead of buying points will probably still lower your interest rate, and maybe even by a bigger amount. This is because a bigger down payment drops your loan-to-value ratio, or LTV, which is the size of your debt compared to the value of the home.
You have no plans to refinance in the near future. Even if you plan to stay in the house for a while, you may want to refinance in the future because interest rates are pretty high right now. Your mortgage interest rate will change if you refinance, so if you think that might be in your future, it might be best not to buy mortgage points right now.
Borrowers should think about all the things that could affect how long they plan to stay in the home with that mortgage, such as the size and location of the property, their job situation, and the current mortgage rate environment, and then figure out how long it would take them to break even before buying mortgage points.
Where does it start to pay off?
To figure out the “breakeven point” where this customer will get back what he or she spent on pre-paid interest, split the cost of the mortgage points by the amount the lower rate saves each month:
$6,400 times $104 equals 61.5 months
This shows that the user would have to live in the home for just over 61 months, or about five years, to make up for the cost of the discount points.
APR is used to compare payments.
Taking a look at your mortgage’s yearly percentage rate (APR) can help you compare loans with different rates and points. The APR takes into account not only the interest rate but also the points you pay and any fees the lender may charge. This can help you understand things better and make it easier to compare similar loans.
You can choose whether or not to pay points on a debt based on whether or not this is a good idea for you. Once you get a price from a lender, run the numbers to see if it’s worth it to pay points to lower the rate for the length of your loan.