Mortgage points, also referred to as discount points give buyers the option to pay a fee during the closing process in order to decrease the interest rate on their loan. The term “points” is commonly used to represent a percentage of the loan amount.
To illustrate if you choose to purchase one discount point it will cost you 1% of your loan amount. Result in a 0.25% reduction, in your interest rate. This means that if you secure a mortgage with an interest rate of 6.5% and decide to buy one mortgage discount point your interest rate will be lowered to 6.25%.
Although less frequent you might also hear your lender mention points when discussing origination fees and lender credits. These expenses are also expressed as a percentage of your loan amount. Are paid during the closing process.
How do mortgage points function?
When you opt for purchasing mortgage discount points essentially what you’re doing is paying upfront for some of the interest in exchange for a reduced interest rate and lower monthly payments. The payment for these mortgage points will be made alongside your closing costs. Will be specified on both your loan estimate and closing disclosure.
Lenders may allow you to purchase points (such as 0.5% of the loan amount) which can lead to a reduction in your interest rate, by 0.125%.Keep in mind that the points you purchase the lower your interest rate will be. However it’s important to note that there are state laws, in place that restrict the closing costs a buyer can pay which means there is a limit on the number of points you can actually buy.
It’s worth noting that lenders typically only offer discount points during the fixed rate period of your loan term. So if you’re financing your home with an adjustable rate mortgage you can purchase points to reduce the interest rate for the years when your rate is fixed but not during the variable rate period.
Here’s a helpful tip;
When comparing mortgage options make sure to look at both the interest rate and APR (Annual Percentage Rate). Sometimes one lender may advertise an interest rate than another. Their APR might be higher due to factors like points cost and lender fees. Taking into account both factors will give you an comparison between lenders.
Now lets talk about how much mortgage points cost. Each discount point amounts to 1% of your loan amount. Decreases your interest rate by 0.25%. For example if you have a $300,000 loan at an interest rate of 6.25% purchasing one discount point would require a payment of $3,000 and lower your interest rate, to a flat 6%.
If you decide to purchase any points they will be included in your closing costs unless you have previously negotiated with the seller to cover the cost of points, on your behalf.
To calculate the Months to Break Point;
(Point cost / Monthly Payment Savings) = Months to Break Point
The longer you reside in your new home the higher the likelihood that you will reach this break even point. Here’s an example; if you decide to lower your interest rate from 6.5% to 6% by purchasing 1 mortgage discount point on a $300,000 mortgage with a 30 year fixed rate and a 3% down payment it would take 5 years and 2 months for you to reach your break point.
Lets address some asked questions, about mortgage points now;
Paying an amount, towards your payment has its benefits. It helps increase your equity in the home and reduces the amount you need to borrow since it goes towards the principal. On the hand when you buy mortgage discount points your money is allocated towards the interest, which means you’ll own less of the home and have to borrow more.
Some people prefer buying discount points of making a down payment because it usually involves a lower upfront cost. However you typically need to put down 10% before seeing substantial monthly savings. If you make a 20% payment you can avoid the expense of mortgage insurance thereby saving even more over the term of your loan. I recommend consulting with a mortgage expert who can help assess which option works best for your loan details, available funds, monthly budget and how long you plan to reside in the home.
Now lets address whether points are equivalent to lender credits.
Lender credits work differently than discount points. Of paying cash upfront for a reduced interest rate as with discount points lender credits involve accepting a slightly higher interest rate in exchange for money, from your lender to cover closing costs.
This option can be attractive, for buyers who have the means to afford the payment but may not have cash on hand to cover all their closing costs. The specific amount of credits that a lender offers may vary, so its recommended to initiate the discussion during the pre approval process.
When should you consider purchasing mortgage points?
Purchasing mortgage points makes sense when you anticipate living in your home enough to reach the break even point. Typically it is not advisable to buy discount points if you are capable of making a payment. The more money you are able to put down the lower your monthly mortgage payments will. The greater equity you will have in your home.
How much does buying one point affect your interest rate?
Each point you buy on your mortgage reduces your interest rate by 0.25%. For instance if you are taking out a $300,000 home loan with a 10% payment (resulting in a loan amount of $270,000) purchasing one point would cost $2,700. With an interest rate of 6.5% buying one discount point would lower it to 6.25%.
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