Once you’ve qualified for a mortgage and found your new home, your loan officer will likely bring up the topic of “points.” You may have heard that mortgage points can mean a lower interest rate for your loan, which they do, but they come at a cost.
For some people, the whole concept of points can seem confusing. What exactly are they? How do they work? And do you need them? Sit back and relax, we’ll explain everything below.
So, what is a mortgage point?
In simple terms, a mortgage point (also known as a “discount point”) can be thought of as an optional fee that you pay to reduce the interest rate on your loan. Many people refer to the purchase of mortgage points as “buying down the rate.” Essentially, when you buy a mortgage point, you pay some of your loan interest up front in order to lock in a lower interest rate for the entire term of your home loan.
It’s important to clarify the difference between a “discount point” and a “mortgage origination point,” as the two terms are commonly confused. Where discount points are fees that represent prepaid interest and are paid up front, origination points are fees that lenders charge for closing your loan. Origination points can be rolled into your home loan balance and paid over time, but they do not save you money on interest.
How do mortgage points get calculated?
The typical cost of one mortgage discount point is 1% of your total mortgage amount. For example, if your mortgage is $300,000, buying one discount point will cost you $3,000. By purchasing that discount point, you would typically reduce your loan interest rate by 0.25%. So, if you were offered an interest rate of 3.25% on a 30-year fixed-rate mortgage, purchasing a discount point would lower your rate to 3.00%.
Using our $300,000 example, buying one discount point would lower your mortgage payment (principal and interest only) by $41 a month. Interest-wise, it would also lower the total cost of your mortgage over the life of the loan from $470,160 (at 3.25%) to $455,400 (at 3.00%). You would save nearly $15,000 over the life of the loan, assuming you kept the loan for 30 years. So, the $3,000 up-front cost would seem to be well worth it.
We should note that since mortgage interest rates fluctuate daily, and since there is no official set cost for discount points, these numbers can vary by lender. Also, most lenders will offer a chance to purchase fractions of points. This means you don’t always have to pony up the entire 1% of your loan to lower your rate. You can opt to purchase half a point (0.50% of the loan amount) or a quarter of a point (0.25% of the loan amount) or any other available fraction of the loan amount instead.
Should I pay for mortgage points?
In a nutshell, it depends. Remember, purchasing mortgage discount points is completely optional. To determine if it’s the right choice for you, a few factors should be taken into consideration:
Your up-front budget. Most homebuyers have spent years saving up for a down payment. If you have additional cash available to spend on lowering your interest rate, discount points might be a good option for you. It not, it may be better to keep some of your cash on hand for emergencies and moving expenses.
Time in the home. The longer you plan to stay in your home, the greater benefit discount points have. The “break-even point” (when up-front fees equal what you save) will vary depending on your specific loan terms, but we typically see buyers reaching this stage within 5 to10 years. This means that it would make sense for you to consider paying a discount point if you plan to stay in your home more than 5 to10 years.
Your credit score. If you have a lower credit score, you’re not going to qualify for the best rates available. In the long run, that means you’re paying more for your mortgage loan. If you’re in this boat, purchasing discount points gives you the option to get a better interest rate and lower your monthly payments.
If you’re interested in learning more about mortgage discount points, or have other questions about the loan process, one of our loan experts will be happy to answer them. Reach out to us at inquiries@rightbyyoumortgage.com, or call us at 877-552-2242. We’re here to help.
