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New homeowners look at their PCGetting a low interest rate on mortgage can make buying a home or refinancing an existing loan affordable. You could wait for mortgage rates to drop before applying for a loan but buying mortgage points is another option. Also referred to as discount points, mortgage points allow you to reduce the interest rate on your home loan in exchange for a fee. This could reduce your mortgage payment and potentially save you money over the life of the loan. But getting discount points may not be right for every homebuyer.

Mortgage Points, Definition

So what are mortgage points? Mortgage points essentially refer to a fee you pay your mortgage lender to reduce the interest rate on your loan. This is also known as buying down the rate on a mortgage.

There are two types of mortgage points you can pay for: origination points and discount points. An origination point is a fee that’s paid to your lender to reduce loan origination fees. It has no impact on your interest rate whatsoever, but discount points do.

Mortgage discount points can directly reduce the interest rate on your home loan. The more points you purchase, the bigger the reduction in your interest rate. A lower interest rate on a mortgage can mean less interest paid in total over the life of the loan. But it’s helpful to understand exactly how mortgage points work before buying in.

How Do Mortgage Points Work?

Buyers sign a purchase agreement for a new houseWhen understanding mortgage points, there are two sets of numbers to focus on. The first is how much a mortgage point actually costs.  Generally, one mortgage point is equal to 1% of your mortgage. So for every $100,000 you borrow, for example, one mortgage point would be equal to $1,000. Remember, these are fees you’re paying to the lender so you have to factor that into your overall cost of home buying and what’s due at closing.

The other set of numbers to know is how much of an interest rate reduction one mortgage point can yield. Typically, lenders reduce your mortgage interest rate by 0.25% for each mortgage point you pay. So say you’re buying a home with a $300,000 mortgage at 3.25%. One point would cost you $3,000, but in exchange your lender drops your mortgage rate down to an even 3%. The more points you buy, the lower your interest rate can go.

That sounds good, but it’s important to keep in mind what you’re actually doing here. When you buy discount points against a mortgage, you’re essentially prepaying some of the interest on the loan up front. You’d have to do some additional math to decide if it makes sense financially to purchase discount points.

How Much Could You Save by Purchasing Mortgage Points?

That’s a good question and the answer is that it depends largely on several things, including:

  • Your mortgage term
  • The amount you’re borrowing and your down payment
  • Your initial interest rate
  • The number of points you plan to buy
  • How long you plan to stay in the home

Doing the math on discount points can help you figure out if it’s worth paying them, based on the break-even point. The break-even point is when the amount of money you saved in interest by purchasing points equals the amount you paid to buy them.

For example, say you want to buy a $300,000 home with a 30-year term. The lender offers you the option of getting a mortgage at 3.5% with no points or paying two points to reduce your rate to 3%. You’d need to pay $6,000 to cover the points but that would reduce your monthly principal payment from $1,347 to $1,265. You’d hit your break-even point in approximately 6.1 years.

But what about the interest savings? If you were to stick with your original rate of 3.5%, you’d pay $184,968 in interest charges over the life of the loan. But if you were to spend the $6,000 to buy down points that would reduce the interest paid on the mortgage to $155,332. Once you deduct the $6,000 you paid for points the result would be a net interest savings of $23,636.

That assumes, however, that you stay in the home for the full 30 years of the mortgage term and don’t refinance to a lower rate at some point. A good rule of thumb to keep in mind when deciding whether to buy points relates to how long you plan to stay in the home. Generally, the longer you stay put, the more you’ll save on interest once you pass the break-even point.

That’s important to keep in mind if you’re considering buying discount points for an adjustable-rate mortgage. If you plan to sell the home before the rate adjusts then buying points up front may not be worth it if you’re already getting a lower rate than you would with a conventional loan. And selling before you hit the break-even point on any type of mortgage means losing money since you won’t have time to earn back the points you paid in interest savings.

Can You Negotiate Mortgage Points?

Suburban houseMaybe, though it can depend on several factors and how strong of a position you’re in financially. Your lender may be more willing to negotiate fees for purchasing discount points when you’re bringing a larger down payment to the table and/or have a higher credit score. Negotiating mortgage points can help you snag a break on interest while reducing the amount needed for closing.

Remember, alongside mortgage point fees you also have to pay other closing costs, such as legal fees and recording fees, all of which can add up to between 2% and 5% of the home’s purchase price.

If you have a credit score in the excellent range, however, negotiating mortgage points or buying them may not even matter. An excellent credit score may already qualify you for the lowest rates possible on a mortgage loan or refinance loan anyway.

The Bottom Line

Buying mortgage points can make sense for some home buyers, but it all depends on how much you want to try and save on a loan and how long you plan to stay in the home. Talking to your lender about the potential costs and doing the math yourself to project estimated savings can help you decide if buying discount points is worth it.

Tips for Investing

  • Consider talking to a financial advisor about whether buying points is a good move financially if you’re planning to buy a home. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool can help you connect with professional advisors in your local area. It takes just a few minutes to get your financial advisor recommendations. If you’re ready, get started now.
  • A free mortgage calculator can give you a quick overview of what is affordable for you. And if you’re buying a home specifically as an investment property, either to rent or as a fix and flip, be sure to weigh what you’ll have to put into it versus the returns it can generate.

Photo credit: ©iStock.com/Prostock-Studio, ©iStock.com/skynesher, ©iStock.com/jhorrocks

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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