What are mortgage points
Mortgage borrowers looking for a lower rate may well be curious about mortgage points. What are they? How do they work? Are they a good option? The first two answers are easy. The third may be more nuanced as it depends to some extent on your personal situation.
What are mortgage points?
Mortgage points are essentially a form of prepaid interest. Borrowers who choose to pay this interest up front receive a lower rate for the duration of their loan.
One point equals 1 percent—one percentage point—of your loan amount. If your loan amount is, say, $100,000, one point equals $1,000.
Mortgage points are sometimes called discount points or mortgage discount points because they're converted into a lower, or discounted, mortgage rate. Paying mortgage points is sometimes described as buying down your rate. Don't confuse mortgage points with origination points. Origination points are a lender fee that's calculated on a percentage basis. Mortgage points are optional. Origination points and other origination fees aren't.
How do mortgage points work?
The best way to understand how mortgage points work is to study a few examples. This chart shows three hypothetical combinations of mortgage points and discounted rates for a $150,000 fixed-rate mortgage with a 30-year term.
The total interest savings doesn't account for the upfront cost of the mortgage points. A simple break-even analysis shows how many months it will take for the lower payment to recoup that cost.
In the example, paying two mortgage points upfront lowers the borrowers' rate from 6.5% to 6%. With the $150,000 loan amount, the points cost the borrowers $3,000. The borrowers' monthly payment drops from $948.10 to $899.33, a savings of $48.77.
Divide $3,000 by $48.77, and the result is about 61.5 months, or a little longer than five years. At that time, the borrowers will break even on the upfront cost of their mortgage points. After that time, the borrowers will continue to save $48.77 every month as long as they keep their mortgage.
Are mortgage points a good option?
It's not always easy to decide whether paying mortgage points makes sense. If you're weighing your options, here are some factors to consider:
- Paying 1 mortgage point may not lower your rate by exactly 0.25%, as shown in the example. The ratio between mortgage points and rate discounts can vary depending on your lender's policies, the specifics of your loan, and other factors.
- Paying mortgage points generally makes more sense if you plan to keep your loan for many years beyond the break-even point.
- A break-even analysis may be less helpful if your mortgage has a variable rate, which can change over time. Hybrid loans and adjustable-rate mortgages (ARMs) fall into this category.
- Mortgage points must be paid at closing. That means you'll need to have enough cash on hand for your mortgage points as well as your down payment and closing costs.
- You may be approved for a larger loan amount if you choose to pay mortgage points.
- Mortgage points may be deductible when you file your income tax returns. Ask your tax preparer for details.
Still not sure if you should pay mortgage points? Your loan officer can help you decide whether this option is a good choice for you.
