You’re bound to come across mortgage points as you dive into the down payment and monthly costs of your home loan. Mortgage points can be confusing. They reduce your monthly mortgage rate, but they cost you money - and aren’t right for everyone.
In this blog, we’ll review what mortgage points are, how they are calculated into your loan, and when you should and shouldn’t use mortgage points.
What are mortgage points?
Mortgage points, often called “discount points,” are fees paid to the mortgage lender during the closing of your home in exchange for a reduced interest rate on your loan.
One mortgage point is worth 1% of the loan amount. In other words, for a $100,000 mortgage, one point is equal to $1,000. When you pay for points upfront, you in exchange lower the interest rate over the life of the loan. This is often referred to as “buying down the rate” and reduces your monthly mortgage payment.
For every point paid, the interest rate is usually reduced by approximately 0.25%. Most lenders will allow borrowers to pay between one and four points (between 1% and 4% of the loan amount). However, borrowers don't have to pay for a whole point. They can buy half a point or even a quarter of a point. Sometimes, as an incentive, a seller or home developer will agree to pay points. In the end, mortgage points are optional.
Another type of points you may hear of are “origination points.” Origination points cover the lender’s cost to process the loan and can help pay for closing costs. In most cases, the origination points can be negotiable. If origination points are lowered, the interest rate will be raised so the lender will eventually earn their commission from the yield spread premium. For borrowers who plan on refinancing or selling in the near future, this can be a very good deal. For everyone else, the higher interest fee will almost always amount to much more over the long-term than the origination points.
How are mortgage points calculated into a loan?
If you’re interested in using mortgage points, you will want to see how they affect the interest rate of the life of the loan. The longer you stay in the home, the more money you’ll save. You’ll want to know the break-even point - when you begin to see the return on paying for the points upfront. If you plan on only living in the house a few years, you likely will not hit your break-even point. Let’s look at an example.
In the table below, we are looking at a mortgage of 30-year mortgage of $300,000 at a fixed rate of 5%.
The table above shows your possible monthly savings. How much you can save depends on the amount of time you plan on staying in the home. In this case, you would hit the break-even point at around 5.5 years.
If you want to see a live breakdown of mortgage options with points included, head to our home page and use our free mortgage calculator. Mortgage points will automatically be included in your loan options after you search rates. When you’re getting pre-approved, you’ll also be able to review mortgage points in your Loan Estimate and in your Closing Disclosure so you know how much you’ll need to pay at closing.
When should I use mortgage points?
As we’ve said - the longer you plan on staying in the home you bought, the more savings you’ll receive over the life of the loan. But there are two main factors to consider when you’re debating on using mortgage points:
1. How long will you live in the home?
- If you plan on staying in the home for the duration of the mortgage, paying points will save you a significant amount of money. If you plan on only staying for a few years, it’s likely not worth it.
2. How much money do you have for the down payment?
- If you have to decide on making a 20% down payment or an 18% down payment and paying mortgage points, don’t pay for the points. When you put less than 20% down, you’ll have to pay monthly mortgage insurance, which will negate the savings the points gave you.
If you feel like mortgage points will be a good option for you, your lender will show you all the details on how they will work and how much more money you’ll need to bring to the closing table. To get started, use our free mortgage calculator to take an in-depth look at your estimated closing costs, fees, and monthly payments with mortgage points included.
A few more thing to consider about mortgage points:
- If you do pay for mortgage points, they are tax-deductible as interest on a primary residence or even a second home. All the points can be deducted in the year the mortgage was made.
- Make sure you have a fixed-rate mortgage. If not, at least make sure you will break even before your initial fixed-rate period ends.
Choosing whether to pay points takes a lot of consideration. Talking with your mortgage lender would be a wise decision before you make your choice. They will be able to offer you in-depth facts and see what makes the most sense for your situation. If you have additional questions or want to see if mortgage points work for your home purchase, use the chat in the lower right-hand corner of your screen, email us at firstname.lastname@example.org, or call 855-610-1112.
In addition, if you’re in the early stages of buying a home, make sure to download our free guide for first-time home buyers. Mortgage approvals can get complex. Having a step-by-step guide will not only help you avoid common mistakes, but it also will give you a clear idea of what to expect as you buy your home.