What are Mortgage Points?

While shopping for a home loan, your loan officer might mention the option of buying down your mortgage rate by paying discount points. This can make sense in some cases, especially if you plan on living in the home for a long time. Here's everything you need to know about paying points to buy down your mortgage rate and how it might be the right option for you.

What are mortgage points?

Mortgage points, or discount points, provide a way for you to obtain a lower interest rate, essentially allowing you to pay for a lower interest rate. A rate is considered ‘at par’ when you do not pay money to obtain the rate nor receive a credit to obtain the rate. One discount point is equal to 1% of the total amount that will be financed.

If you have the money available to put down at closing, paying mortgage points to buy down your interest rate can be advantageous. By reducing the interest rate on your loan, you can decrease your monthly payments and pay less interest over the life of your loan, which may also increase your chances of qualifying for the loan. It's also worth noting that in certain circumstances, mortgage points may be tax deductible and can be itemized as home mortgage interest on a Schedule A. Please consult your tax advisor.

How are mortgage points calculated?

The value of your discount points will depend on the loan amount. The higher the loan amount, the higher the value of each point. This is because the value of one mortgage point is calculated as 1% of the total loan amount.

1 point = Loan amount x 1%

Keep in mind this is the amount on the home loan itself, not the purchase price of the home. For example, if you take out a \$100,000 home loan and pay one mortgage point, that mortgage point will cost \$1,000, as shown in the table below.

 Loan Value Discount Point Formula Dollar Amount \$100,000 1 100,000 x 1% \$1,000

How much is .25 points on a mortgage?

Usually, mortgage points lower your interest rate in increments of 0.25. So, if you qualify for a 4.25% interest rate and you pay one mortgage point, your rate would typically be lowered to 4%. If you pay two mortgage points and each point lowers your rate in .25 increments, your rate would be lowered to 3.75%. Please keep in mind that current market interest rates are subject to fluctuation and are likely to vary greatly each day depending on market conditions.

Securing a rate that's even 0.5% lower than the current par rate can make a huge difference in your monthly payments and the overall cost of your loan. The table below shows how much your monthly payments would be on a \$300,000 30-year mortgage loan if you didn't buy mortgage points versus if you bought one or two mortgage points.

 No points 1 point 2 points Cost for points \$0 \$3,000 \$6,000 Interest rate 3.25% 3.00% 2.75% Monthly payment \$1,306 \$1,265 \$1,225

By buying two discount points, you'd save \$81 per month or \$972 per year. In 74 months (about 6 years), you’ll have saved \$5,994, therefore breaking even given that you spent \$6,000 on two mortgage points. Simply put, the break-even point is when your savings equal your costs (i.e., points, fees, insurance, etc.).

Paying mortgage points to buy down your interest rate can be a good way to save money over time as long as you have enough money to pay for them upfront as part of your closing costs. As illustrated in the example above, after a certain number of years, mortgage points can pay for themselves in the form of interest saved.

To determine if discount points are right for you, the first thing you should ask yourself is "how long am I going to live in the home?" If you plan to sell the home or refinance within a couple of years, it may not make sense to pay discount points. On the other side of the coin, if you plan to stay in your home for a while paying discount points will save you money.

Your next question should be, "What is my break-even?" Figuring out your break-even point will help guide your decision. Asking your lender how much you would save per month by paying a certain number of discount points is the simplest way to calculate the break-even point.  For example, one discount point in the example above was purchased for \$3,000, and it reduced the monthly payment by \$44. To calculate the break-even point, you would then divide \$3,000 by the \$44 saved per month for a break-even point of 68.18 months. Divide that by 12, and the break-even for this example is 5.68 years.

The bottom line is that decisions regarding purchasing discount points should be made consciously and strategically. It's a long-term investment with a long-term return.

Learn more about today’s mortgage rates to get a sense of what kind of rate you might qualify for. From there, you can decide whether mortgage points are the right investment for you.

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