Understanding all the various mortgage options and structures can sometimes feel like you need to get a new degree to comprehend it all. Oksana Sherman from Suncoast Credit Union recently shared a great overview of mortgage points and how they are used by Libby Wells @EAWells77 October 29, 2018 in Mortgages
What are mortgage points?
When you take out a mortgage, whether you’re buying a house or refinancing an existing home loan, it’s likely the lender will charge you “points.”
A point is a fee equal to 1 percent of the mortgage amount. A 30-year, $200,000 mortgage might have an interest rate of 4.5 percent but come with a charge of 1 mortgage point, or $2,000.
A lender can charge zero points, 1 point or several points. Points don’t always have to be round numbers. A lender might charge 1.5 points, which would come to $3,000 on a $200,000 mortgage.
You’ll see the points listed on the Loan Estimate, which the lender gives you soon after you apply for the mortgage, and on the Closing Disclosure, which you get several days before settlement. Points are paid at closing.
There are essentially two kinds of mortgage points:
1. Discount points.
2. Origination points.
What are discount points?
Discount points are actually prepaid interest on the mortgage loan. The more points you pay, the lower the interest rate on the loan and vice versa.
Paying points is often referred to as “buying down the rate.” A loan with zero points should have a higher interest rate than a loan with 1 point.
Borrowers usually can pay from zero to several points, depending on how much they want to reduce their rate. Every mortgage lender has its own price structure, so how much you can lower your interest rate by paying points depends on the lender, the type of loan and the mortgage market.
Generally, though, each point you pay will lower your interest rate by one-eighth to one-quarter of a percent.
What are origination points?
Origination points cover the lender’s cost of processing the loan. They’re a way to pay closing costs – and, they’re negotiable. The number of origination points lenders charge varies, so be sure to ask about them when you are shopping for a mortgage lender.
Also, lenders may use different terms for points, such as “maximum loan charges” or “loan discounts,” so if you’re confused, ask your lender for clarification.
When is it worth it to buy points?
Deciding whether to pay mortgage points depends largely on two factors:
1. How long you plan to stay in the home.
2. How much money you have to put down at closing.
If you are planning to move or refinance in a few years, paying points is likely not a good deal.
“Buying down your interest rate through discount points is a financial decision that looks better the longer you own the home,” says Greg McBride, CFA, Bankrate’s chief financial analyst.
“The upfront payment of points translates into a permanently lower monthly mortgage payment, so the longer you benefit from those lower payments, the better return on investment you get from paying points.”
If you need your closing costs to be as low as possible, choose the zero-points option on your loan program.
Do the math
Let’s say you get a 30-year fixed-rate mortgage for $200,000 at 6 percent interest with no points. The monthly principal and interest payment would be $1,199.
If you pay 2 discount points at closing (that’s $4,000) you might be able to cut the interest rate to 5.5 percent, with a monthly payment of $1,136. That trims your payment by $63 per month.
It would take 64 months, or more than five years, to get back the $4,000 spent upfront on discount points (4,000 / 63 = 63.4, or about 5.3 years).
If you’re sure you will own the house for more than 5 1/2 years, you save money by paying the points.
If you don’t pay cash for points at closing, you might be able to finance them and roll them into your loan. Let’s say you get a 30-year, fixed-rate mortgage for $150,000. You can pay 4 points ($6,000) to get a rate of 5 percent, or you can opt for zero points and get a 6 percent rate.
Monthly principal and interest payments on 5 percent would be $805; monthly payments on 6 percent would be $899. You cut the monthly payment by $94 if you buy the points, but you increase your loan balance to $156,000 by financing them.
Nevertheless, buying those points would save you almost $34,000 in interest over the life of the loan if you stay in the house.
Use Bankrate’s mortgage calculator to figure your monthly payment and see the amortization schedule.
If you’re not sure how long you’ll stay in the home or when you’ll refinance, ask your loan officer to calculate your costs over different lengths of time.