The interest rate you receive when you first decide on a mortgage loan amount may not be the same rate that stays with you throughout the loan. One way you can raise or lower your interest rate is by buying mortgage points at the beginning of your loan.
What Are Mortgage Points?
Mortgage points are a kind of prepaid interest offered by the lender as a way for borrowers to buy down their mortgage interest rates. By paying a one-time fee, lenders will usually allow borrowers to buy-down their interest rate by one to three points, with one mortgage point being equal to one percent of the total loan amount.
There are two types of mortgage points borrowers should be aware of: origination points and discount points.
Origination Points vs. Discount Points
Origination points are the mortgage points you pay to your loan originator to cover your loan origination costs. Paying these mortgage points won’t lower your interest rate, but the origination costs won’t be rolled into your loan, either. Discount points, on the other hand, are mortgage points you pay to lower your interest rate. The more discount points you pay, the lower your interest rate drops. Using mortgage points can either save you money or end up costing you more, depending on what you do with your mortgage loan after closing.
Mortgage Discount Points vs. Down Payment
A down payment on your home plays a role in determining how much your monthly payment will be. Your monthly mortgage payment decreases with a larger down payment. Therefore, both mortgage discount points and large down payments can save you money monthly. When deciding whether to purchase points vs. increase your down payment amount, consider your estimated length of loan ownership.
If you plan on keeping your loan (i.e. your home) for a long period of time, purchasing mortgage discount points is a good option. If, on the other hand, you plan to own your home for only a few years, paying a large down payment is a good option.
How Do You Calculate Mortgage Points?
Here are a few examples to show how to calculate discount points, assuming your loan is $200,000:
- 1 discount point would cost $2,000
- >0.5 discount points would cost $1,000
- >0.25 discount points would cost $500
In turn, buying those points would help lower your monthly mortgage payments. For a more personalized mortgage points calculation using your own numbers, use a discount points calculator.
Is It Worth It To Buy Mortgage Points?
Essentially, for buying mortgage points to be worth your while, you’ll need to guarantee you’ll hit a “break-even” point sooner or later in the life of your loan. This is the point in your home loan where the interest saved is equal to the amount paid in mortgage points.
As a general rule of thumb, the bigger the mortgage, its length, and interest rates, the more money discount points will save you. Buying points on shorter-term mortgages or those with low interest rates may not result in any savings.
Before deciding how many discount points to buy, consider how long you plan on staying in your home. Typically, the more points you buy, the longer you’d want to stay to make back the money it took to buy the points. If you sell the house too soon, you won’t recoup the costs and can lose money.
There are a variety of additional considerations when deciding whether or not to purchase mortgage discount points, such as monthly savings, alternative fund usage options, refinancing potential and tax implications.
To ensure purchasing mortgage discount points is worth it, determine how much you will save monthly as well as how long it will take you to get back the initial investment made.
Alternative Fund Usage
Mortgage discount points cost money. Consider if paying for points is the best use of your funds, both personally and as a long term investment.
Consider the likelihood of changes in interest rates. It may be a better option to wait until interest rates fall to refinance in the future rather than pay for mortgage discount points now.
Mortgage points can also be tax deductible. Since they’re a form of interest, points are usually 100% tax deductible the year you buy your house. You could also negotiate with your lender and have them pay for the points, but still deduct the cost of the points on your taxes.
Remember to compare today’s mortgage rates with and without discount points to see which loan bests suits your financial situation.