Mortgage points are fees that you pay your mortgage lender upfront in order to reduce the interest rate on your loan and, in turn, your monthly payments. A single mortgage point equals 1% of your mortgage amount. So if you take out a $200,000 mortgage, a point is equal to $2,000. By doing this, you’ll pay more now, but you’ll be reducing your long-term costs. Like any financial decision, this isn’t necessarily a good move for everyone, though. As you decide if paying for mortgage points makes sense for you, speak with a financial advisor about how a home loan can affect your financial plan.
What Are Mortgage Points?
Mortgage points essentially are special payments that you make at the closing of your mortgage in exchange for a lower interest rate and monthly payments on your loan. That’s why buying points are often referred to as “buying down the rate.” The move can lower what you pay your mortgage lender in the long run, and it can also get you closer to owning your own home outright sooner.
In the home buying world, there are two types of mortgage points:
1. Discount Points
Discount points are basically mortgage points as described above. The more points you buy, the more your rate falls. Lenders set their own mortgage point framework. So the depth of how far you can dip your rate ultimately depends on your lender’s terms, the type of loan and the overall housing market. But you can expect to lower yours by one-eighth to one-quarter of a percent. Discount points are tax deductible for the first $750,000 of your mortgage loan.
When deciding to pay for discount points it’s important to weigh how long you plan to stay in your house and how much available cash you have at closing. The longer you stay in your house, the more money you end up saving by buying discount points. Likewise, the more money you have available at closing, then the better chance you have to pay for the discount points.
2. Origination Points
These cover the expenses your lender made for getting your loan processed. The amount of interest you can shave off with discount points can vary, but you can typically negotiate the terms with your lender. These are part of the overall closing costs and some lenders add these in based on your overall credit or borrowing profile. Origination points are not tax-deductible but thankfully many lenders have stopped forcing origination points. Instead, lenders are offering flat-fee or no-fee mortgage options, especially for strong borrowers.
How to Calculate Mortgage Points
Picture a scenario where you take out a 30-year-fixed-rate mortgage for $200,000 with an interest rate of 5.5%. Your monthly payment with no points translates to $1,136.
Then, say you buy two mortgage points for 1% of the loan amount each, or $4,000. As a result, your interest rate dips to 5%. You end up saving $62 a month because your new monthly payment drops to $1,074.
To figure out when you’d get that money back and start saving, divide the amount you paid for your points by the amount of monthly savings ($4,000/$62). The result is 64.5 months or ~5.3 years. So if you stay in your home longer than this, you end up saving money in the long run.
Keep in mind that our example covers only the principal and interest of your loan. It doesn’t account for factors like property taxes or homeowners insurance. Also, you may want to take advantage of various free mortgage point calculators that are available.
When Are Mortgage Points Worth It?
If you are buying a home and have some extra cash to add to your down payment, you can consider buying down the rate. This would lower your payments going forward. This is a particularly good strategy if the seller is willing to pay some closing costs. Often, the process counts points under the seller-paid costs. And if you pay them yourself, mortgage points usually end up tax deductible.
In many refinance cases, closing costs are rolled into the new loan. If you have enough home equity to absorb higher costs, you can pay mortgage points. Then you can finance them into the loan and lower your monthly payment without paying out of pocket.
In addition, if you plan to keep your home for a while, it would be smart to pay points to lower your rate. Paying $2,000 may seem like a steep charge to lower your rate and payment by a small amount. But, if you save $20 on your monthly payment, you will recoup the cost in a little more than eight years.
The lower the rate you can secure upfront, the less likely you are to want to refinance in the future. Even if you pay no points, every time you refinance, you will incur charges. In a low-rate environment, paying points to get the absolute best rate makes sense. You will never want to refinance that loan again.
But when rates are higher, it would actually be better not to buy down the rate. If rates drop in the future, you may have a chance to refinance before you would have fully taken advantage of the points you paid originally.
Should I Pay for Points on My Mortgage?
If you can’t afford to make sizable upfront payments at the closing of your mortgage application, you may want to keep the current interest rate and refinance your mortgage at a later date. Refinancing a mortgage is basically taking out a new loan to pay off your first mortgage, but you shop for a better interest rate and terms on the new one. This makes sense if you’ve made timely payments on your old mortgage, have paid off a decent amount of your principal, and improved your credit score since you first obtained the initial mortgage.
If you’ve got some money in your reserves and can afford it, buying mortgage points may be a worthwhile investment. In general, buying mortgage points is most beneficial when you both intend to stay in your home for a long period of time and can afford mortgage point payments.
If this is the case for you, it helps to first crunch the numbers to see if mortgage points are truly worth it. A financial advisor can help you through this process if you don’t know where to start.
What Are Origination Fees?
Why do so many lenders quote an origination fee? To get a true “no point” loan, lenders must disclose a 1% fee and then give a corresponding 1% rebate. Wouldn’t it make more sense to quote a loan “at par” and let the borrower buy down the rate?
The reason lenders do it this way is because of the disclosure laws in the Dodd-Frank Act. If the lender does not disclose a certain fee in the beginning, it cannot add that fee on later. If a lender discloses a loan estimate before locking in the loan terms, failure to disclose an origination fee (or points) will bind the lender to those terms.
This may sound like a good thing. If rates rise during the loan process, it can force you to take a higher rate. Suppose you applied for a loan when the rate was 3.5%. When you are ready to lock in, the rate is worse. Your loan officer says you can get 3.625% or 3.5% with the cost of a quarter of a point (0.25%). If no points or origination charges show up on your loan estimate, the lender wouldn’t be able to offer you this second option. You would be forced to take the higher rate.
Like any other financial decision, the specifics of whether or not mortgage points are necessary for you will depend on your personal situation. Run some simulations using a mortgage calculator like SmartAsset’s to get an idea of how the purchase or non-purchase of points will affect your long-term mortgage payments. In addition, make sure your mortgage payments will fit into your overall budget.
Tips for Buying a Home
- Buying a home is no small feat, so it can be helpful to work with a financial advisor to figure out your finances beforehand. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have free introductory calls with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Before you fall in love with your dream home, figure out what prices are actually within your budget. To help you out, check out SmartAsset’s how much home can I afford calculator. All you need to know is where you’re looking for homes, your marital status, your annual income, your current debt and your credit score.
- SmartAsset’s no-cost closing cost calculator will help you understand your total closing costs and amount needed at settlement.
Photo credit: ©iStock.com/ziquiu, ©iStock.com/courtneyk, ©iStock.com/bonnie jacobs