What Are Mortgage Points And Are They Worth It?
Are you ready to get a mortgage but not happy with your new mortgage loan’s interest rate? Want a lower one? Mortgage points can help. The interest savings that come from buying points isn’t free, though: You’ll have to pay for each point that you buy, meaning that you must determine whether the upfront money you spend on these points is worth the interest you’ll save by lowering your rate.
What Are Points On A Mortgage?
Mortgage points, often called discount points, are a way for home buyers to pay to lower the interest rate on their home loan. Each mortgage point costs 1% of your mortgage amount and will lower your interest rate by approximately 0.25%. For example, if your lender quotes you an interest rate of 6.5% on your $200,000 mortgage, you’ll likely have the option to buy points to lower that rate. If you buy two points for $4,000, you’ll shave .50% off that rate, dropping it to 6%.
Mortgage points are considered part of closing costs that you’ll pay your lender and other third-party providers to originate your mortgage loan. These costs usually total from 3% to 6% of your mortgage loan amount. You can pay them upfront when you close on your mortgage or add them to your total mortgage amount, meaning you’d pay them back over time when you make your monthly mortgage payments.
Mortgage Points Vs. Origination Points
You might hear the term "origination points" when applying for a mortgage. These are not the same as mortgage or discount points.
Origination points represent the fees that you pay your lender to originate your mortgage loan. These will vary by lender, but one origination point typically equals 1% of your mortgage loan amount.
If you are borrowing $300,000 and your lender charges 1.5 origination points, you'll pay $4,500 to your lender for originating your loan.
Unlike mortgage points, origination points will not lower your mortgage's interest rate.
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How Much Do Mortgage Points Cost?
Mortgage points aren’t free. One point costs 1% of your mortgage loan amount. If you are borrowing $325,000, then, you’ll spend $3,250 for one point or $6,500 for two.
Because each point reduces your interest rate by 0.25%, you’ll need to buy four points to reduce your rate by a full percent.
How Do Mortgage Points Work?
There's no set limit on the number of mortgage points you can buy. Typically, though, most lenders will only let you buy up to four mortgage points.
That's because there are federal and state limits on how much borrowers can pay in closing costs on a mortgage. Lenders can't let you buy so many points that you'll pass these limits. Because these limits vary by state, the number of points you can buy might differ depending on where you live.
Another benefit of mortgage points is that they are tax deductible. Points are considered prepaid mortgage interest. You are allowed to deduct the interest you pay on up to $750,000 worth of mortgage debt if you are married and file your taxes jointly or up to $375,000 if you are single or married and filing separately. To claim this tax benefit, you'll need to fill out IRS Form 1040, Schedule A and itemize your deductions.
Wondering if you should buy mortgage points? It's all about the long game: The longer you plan on living in your home, the more likely it is that the interest savings from buying points will outweigh the front-end costs of this purchase.
When you are shopping for a mortgage and determining whether buying points makes sense, you must first calculate how long it would take you to recoup the upfront costs of purchasing these discount points. This is known as the breakeven period.
To determine your loan's breakeven period, divide the costs of your points by how much you'll save on your payment each month. This will give you the number of months it will take for your monthly savings to equal the upfront costs of your discount points.
Mortgage Loan Points Example
Here's an example of how to determine your breakeven point when buying mortgage points. To do your own calculations, use our mortgage amortization calculators.
Say you borrow $300,000 with a 30-year fixed-rate mortgage. Without points, your interest rate will be 6.5%. If you buy one point, you'll pay $3,000 upfront and lower your interest rate to 6.25%.
By purchasing one point, you'll reach your break-even point in about 61 months, or just 5 years and 1 month. Your monthly mortgage payment -- not including taxes or insurance -- without the point you purchased would be $1,896. With your point, that figure falls to $1,847, resulting in a monthly savings of $49.
If you stay in your home for the full 30 years of your mortgage, you’d save $17,640 by lowering your interest rate from 6.5% to 6.25%.
Is Buying Points On A Mortgage Worth It?
So, is it worth it to buy mortgage points? That depends on your answer to two main questions.
How long do you plan on living in your home?
The longer you stay in your home, the more money you'll save by buying points. If you plan on moving within 5 years or so, it's probably a better financial choice to skip the points. But if you plan on living there for 5 years or more? Buying points will typically pay off.
How much money do you have to put down at closing?
If you are taking out a conventional loan, one not insured by a government agency, and you haven't saved enough money for a down payment of 20% of your home value, you might have to pay for private mortgage insurance (PMI). It typically costs from 0.1% to 2% of your loan amount.
If you are taking out a mortgage of $300,000 and your PMI costs you 1% a year, you'll spend $3,000 a year on PMI or $250 a month.
This could factor into your decision to buy points. If you almost have enough money to come up with a 20% down payment, it will usually make more sense to use your dollars on that instead of buying points.
Coming up with a larger down payment will often give you a lower interest rate, too. Talk with your lender to determine whether you'll get a lower interest rate from a bigger down payment or by buying points.
The Pros And Cons Of Mortgage Discount Points
As with most financial decisions, buying mortgage points comes with both positives and negatives.
Pros Of Mortgage Points
- By buying points, you will lower your interest rate and the amount of interest you pay over the life of your loan. This could save you tens of thousands of dollars, depending on your final interest rate and the amount you are borrowing.
- By lowering your interest rate, you will also lower your monthly mortgage payment. This could help you purchase a home that might otherwise be out of your price range.
- Mortgage points are tax deductible. By buying points, you can lower the income taxes you pay if you itemize taxes.
Cons Of Mortgage Points
- Points are expensive, typically costing 1% of your mortgage amount. If you buy points, it could take several years for the interest savings that they generate to equal the amount you pay for them.
- Buying points increases the amount you pay in closing costs. These are the fees that you pay to your lender and other third-party providers, such as real estate attorneys, title insurance companies and inspectors, to originate your loan.
- If you plan on moving or refinancing soon, you might not reach the breakeven point in which the interest savings from points outweighs the cost of these points.
The Bottom Line
While mortgage points could help reduce the amount of interest you pay on your loan, buying them isn’t the right choice for everyone. You’ll need to determine how long you plan on staying in your home and how long it will take your interest savings to surpass the cost of buying points. Contact our Home Loan Experts if you have questions about whether points make sense for you or if you are ready to get started on applying for a mortgage.