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4. Are Mortgage Points Right For You?

There are various factors that impact your interest rate. To name just a few: the size of your down payment, your median FICO® Score, the term of your loan and how you plan to occupy the property. However, what doesn’t immediately come to mind for most people is the ability to pay to get a lower interest rate.

Within this post, we’ll discuss mortgage points – also referred to as discount points or simply points – and how to make comparisons when shopping for a mortgage. By the time you finish reading, you should have the tools to know whether buying points is right for you.

## What Are Mortgage Points?

Mortgage points are prepaid interest. You pay for points at closing in exchange for a lower interest rate than you would otherwise get if you didn’t pay for the interest up front. One point is equal to 1% of the loan amount. If you were to pay for three points on a \$100,000 mortgage, it would be \$3,000 but three points on a \$300,000 mortgage is \$9,000, so the cost can add up quickly.

You have to do some math to determine whether you think the points will be worth it for you. However, it’s not too complicated, and we’ll break it all down in a minute.

When you’re considering buying points for a lower interest rate, it’s also important to note that you don’t have to pay for a full point to get a lower rate. Points are sold in increments all the way down to 0.125%.

## The Mechanics Of Mortgage Points

When you consider mortgage points, you should know that you can pay for them to lower your interest rate, but your lender can also give you lender credits. This is when they take the money off your closing costs in exchange for you paying a higher rate over the life of the loan. The increments for the lender credits also start at 0.125% of your loan amount. If you’re looking to save on closing costs, this is what a lender is referring to when they talk about a rate that “pays back points.”

If you choose to pay for points to lower your interest rate, it’s important to calculate the breakeven point. Thankfully, this doesn’t require any crazy calculus. The formula is as follows:

Amount paid for points
_________________________________________________
Monthly payment without buying points – monthly payment with points

The result of that equation will give you the amount of time (in months) that it would take to break even on your investment and start saving money for the remainder of the life of your loan. If you do the math and you expect to be in the house for longer than that period of time, it could make sense to buy the points. If you expect to move before the breakeven point, you shouldn’t buy the points, or you should look at purchasing a smaller amount.

## Mortgage Points Example

The easiest way to get a feel for this is to look at a quick example to understand how points work in practice. You can also play around with your own interest rates and loan terms using our amortization calculator.

For the purposes of our example, let’s assume you’re looking at a 30-year fixed loan of \$300,000. The monthly payments below only look at principal and interest. Taxes and insurance will vary. Although we’ve attempted to make this example as realistic as possible, different lenders will give different interest rates for the same amount of points, so it’s worth shopping around.

 Points Cost at Closing Interest Rate Monthly Payment Monthly Payment Savings Break-Even Period Payment Savings on 30-year Loan 0 \$0 4.99% \$1,608.63 N/A N/A N/A 1.25 \$3,750 4.75% \$1,564.94 \$43.69 7 years, 2 months \$15,728.40 1.75 \$5,250 4.5% \$1,520.06 \$88.57 5 years \$31,885.20 2 \$6,000 4.25% \$1,475.82 \$132.81 3 years, 10 months \$47,811.60

## How Many Mortgage Points Can You Buy?

Mortgage lenders don’t set specific limits on how many mortgage points you can buy. That said, there are federal and state guidelines around how much you can be charged to close a mortgage.

While nothing is hard and fast because state rules vary, regulations typically make it hard to purchase more than about four points.

## Should You Buy Mortgage Points Or Make A Higher Down Payment?

Every situation is different, so we won’t get definite advice on the question of whether it’s more worth it to buy mortgage points or make a slightly higher down payment. Since both have the potential to lower your rate, we can go over some factors you should think about, though.

If you’re getting a conventional loan and are on the cusp of having a 20% down payment or equity amount in a refinance, it could make more sense to put whatever money you have toward the down payment rather than buying mortgage points. The reasoning behind this is that you don’t pay for private mortgage insurance (PMI) which can save you a monthly fee in the case of borrower-paid mortgage insurance (BPMI) and keep you from paying a higher rate with lender-paid mortgage insurance (LPMI).

If you’re not close to the 20% threshold, you should work closely with your mortgage lender to determine your options. Interest rates are bucketed based on your median FICO®score and occupancy– whether the property will be your primary home or a vacation or rental home, as well as the size of your down payment. A Home Loan Expert will be able to run the numbers to see if you save more money by paying for a certain number of points or making a slightly higher down payment.

## Understanding The Impact Of Mortgage Points On Adjustable Rate Mortgages (ARMs)

With an ARM, you get an initial fixed rate that’s lower than what you would get for a fixed-rate loan with a comparable term at the beginning of the loan. This typically lasts 5, 7 or 10 years depending on the loan option you go with. The reason mortgage investors are willing to give you that initial rate at a bit of a deal is that the rate can then adjust up or down to match current market conditions, subject to certain caps on upward movement.

The investor has the advantage of not being asked to project inflation not so far in advance because the rate can change at the end of the fixed period. However, it’s important for anyone getting an ARM to note that the points they buy only apply to the initial interest rate, and not to any subsequent adjustments. So some of your point calculations may change if you have fewer years to break even and save money at that payment.

## Comparing Mortgage Rates

When lenders set mortgage rates, you’re not always seeing the zero-point rate for advertising purposes. The rates shown often assume that you’ll be paying for a certain number of points. Lenders are required to disclose the assumptions they make in setting the rates they advertise. Points will be one of those disclosures, along with your median FICO® Score and loan-to-value ratio (LTV)– the inverse of your down payment or equity. For example, if you make a 3% down payment, you have a 97% LTV ratio.

One really easy way to get a feel for the overall cost of the loan is to look at the annual percentage rate (APR). For any loan you get, there will be two interest rates listed. One is the base interest rate you get based on factors like credit, LTV and occupancy. Next to that, there will be a higher rate. This is the APR and it factors in closing costs to come up with the total cost of the loan. The bigger the difference between the interest rate and APR, the more you can expect to pay in closing costs.

Discount points are just one of many factors that affect closing cost, but this does give you some sense of what you need to look for when shopping around. Pay attention to the assumptions associated with any advertised rate.

Now that you have a handle on mortgage points, you should feel that much more confident in your quest for home financing. Whether you’re looking to buy or refinance, you can get started online with Rocket Mortgage® by Quicken Loans® or give one of our Home Loan Experts a call at (800) 785-4788. If you have any questions for us, you can leave them in the comments below!

## This Post Has 9 Comments

1. L. Gibboney says:

Hi I have a question and trying to decide. Purchasing a home for 665 k putting money down so loan amount would be 300 K . The property will be my second home. The rate quoted is 3.875 no points or 3.75 paying like .93 just under 1? Trying to decide if it would be beneficial to do this or just take the slightly higher rate. It’s not a huge payment difference. However it is a higher loan amount.Then your above scenario

1. Kevin Graham says:

Hi L:

So typically points are sold in eighths across the industry and 7/8 would be .875 points, but let’s assume for the moment you’re paying .93 points. The key is to figure out the payment difference and when you would break even in order to see whether it would be worth it for you. Under this scenario, you would pay \$2,790 in points. Our amortization calculator doesn’t give exact numbers because fees vary by state. However, I can give you estimates. Since you didn’t specify a term, I’m using 30 years.

First, you would pay off your initial point investment in just under 11 years. You save \$21.36 on the monthly payment. On that pace, you pay off the points in 130 months which is how I get there (2790/21.36). By making the point payment, you do save over \$7,000 in interest. Of course, if your term is different, it’s going to change the numbers. I encourage you to play with the calculator. I hope this helps!

Thanks,
Kevin Graham

2. John says:

Doing the math on all kinds of scenarios is helpful. One other factor might be that when you pay down points and get a lower rate, you are also putting more money toward your Principle during those first years…so if you should sell in lets say 5 years, you will have paid more toward Principle and will therefore owe the bank less money… which means the investment in points (and that’s how you can view it) will earn not only the amount of savings per month on your payment, but also the amount less you will owe on the house, as well as the potential increased value of the home when you do sell…. If you are looking to diversify all of your assets, another good thing to do, consider this type of ‘investment’ as a further type of diversification… You may be able to earn more off that money if invested, but you may not… it depends on what the market does…and if you already have an amount in the market you are comfortable with and don’t want to assume more risk along those lines, it is reasonable to consider other ways to make money off that money. However, if you have no money in the market, I would say use that money to diversify yourself by putting it into the market rather than taking a larger position in your house… I could be wrong on all this, but it’s just the way I tend to look at things…from as broad of perspective as I can, i.e., from the standpoint of all of your money and how it is working for you across the board.

1. Kevin Graham says:

I agree, John! Everyone’s situation is different, so there is no one-size-fits-all scenario. Thanks for sharing!

3. Joshua Nelms says:

Its smarter to do a refi (aka refinance), all you have to do is..

Get the loan with the original interest rate (which of course, is higher)..
Apply that same amount of money (that would be applied to buy down pts) to the principle balance (which could put at a lower interst rate with that same lender anyway) and REFI the loan ASAP for even more savings. Most folks usually REFI in the first few yrs regardless. (ding dong sound)

Buy down money DOES NOT go to the principle balance, it goes directly to the lender.
Why throw away more money to them? lol…
In short, the Buy-Down Point system is a little magic trick that lenders advertise to trick folks out of even more money upfront… don’t be fooled like most misinformed folks; just refinance (like many folks do anyway) when rates get better or when you pay down principle balance more. Cheers.

1. Kevin Graham says:

Hi Joshua:

I don’t disagree with you about paying down principal to pay less interest. However, you do have to make that a habit. For some, the upfront buy down gives them a consistent monthly payment.

Thanks,
Kevin Graham

4. James says:

The calculations also fail to account for the opportunity cost of the money used to purchase the points. If the funds were instead invested, the break even point gets pushed out even further.

5. andy says:

\$100,000 over 30 years at 6.00% will yield a monthly payment of \$599.55. The same loan with a 5.25% will yield a payment of \$552.20. This gives a monthly savings of \$47.35. But, you paid \$1,000 to get the lower rate. Divide the upfront costs by the monthly savings and you get 21.12 as the break-even point. This is not 16 months, as was shown in the article.

Similarly, most points equate to a reduction of 0.125%. So, for a \$271,890 loan at 4.6%, you can buy a point for \$2,718.90 to reduce the rate to 4.475%. Per the article, the break even point in years would be 1/0.125 = 8 years. But, do the math. The monthly payment on this principal with 4.6% is \$1,393.83. The monthly payment with the lower 4.475% is \$1,373.59. The monthly savings is \$20.24. To pay off the \$2,718.90, you need a little more than 134 months. That equates to a little more than 11 years … a full 3 years (or 37.5% longer) more than the approximation given by points/rate diff.

Calculations done with MS Excel 2010. Alternatively, you can do it by hand using c = rP/(1-(1+r)^-N), where c is the payment, r is the monthly rate, P is the principal, and N is the loan terms.

As is always the case, don’t take shortcuts when playing with this much money. Mr. Closson probably should follow his own advice and go back to math class.

1. Clayton Closson says:

Andy

You are absolutely right. . I appreciate your comment and I will do a couple of things.

1) Correct the math
2) Send you a Starbucks card for your help in keeping our site correct (if you like Starbucks)

Send me an email with your contact info and I’ll get your card in the mail.

Thanks again. Clayton Closson (claytonclosson@quickenloans.com)