A guide to mortgage points
Quick insights
- Mortgage points allow you to lower your interest rate by paying an upfront fee, potentially saving you significant money over the life of your loan.
- Calculating your break-even point will help you determine if buying points is worth the investment, especially if you plan to sell or refinance before recouping the cost.
- Mortgage points are most beneficial when you have extra cash after your down payment, plan to stay in your home long-term and are dealing with higher interest rates. However, mortgage points may not be suitable for all borrowers or loan products.
As a savvy homebuyer, you already know the importance of shopping around for the best mortgage rate and negotiating prices. But what if we told you there was another step you could possibly take to make your rates even more competitive?
Today, we'll be discussing mortgage points, how they work, how much they cost, and how to determine if they’re worth the investment.
What are mortgage points?
Mortgage points, also called mortgage discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate on a mortgage. The process is often referred to as “buying down the rate.” Each mortgage point typically costs 1% of the total loan amount and can lower the interest rate by a certain amount, usually 0.25%, although this can vary based on your lender and market conditions.
Buying points can be beneficial if you plan to stay in the home for a long time, as the savings on interest over the life of the loan can outweigh the upfront cost of the points.
Mortgage points vs. origination points
You may also see the term “mortgage origination points” on your loan offer. These points are not the same as mortgage discount points. The term “mortgage origination points” refers to the origination fees your lender charges you to process your loan. Unlike mortgage points, origination points do not reduce the interest rate. If you owe them, they’re usually included with your closing costs. Not all lenders charge origination points.
How do mortgage points work?
Next, let’s talk about how mortgage points work so you can decide whether it’s worth it for you.
Essentially, each mortgage point you buy will reduce your interest rate by a set percentage point, with lenders capping the number of points you can buy. The points are paid at the time of closing or rolled into the overall loan, which increases the total amount financed and the interest paid over the life of the loan. Your lender is responsible for calculating the cost of points that were purchased before adding them to the other closing costs.
Each mortgage point usually costs one percent of your total loan amount, and lowers the interest rate on your monthly payments by 0.25%.
How much is 1 point worth in a mortgage?
Here’s how buying points for a mortgage might affect your loan over time.
The following example is for illustrative purposes only. Actual costs and savings will vary based on your loan terms, lender and market conditions.
| Mortgage points | Reduction in interest rate | Cost per $100,000 borrowed |
| 1/2 Point | 0.125% | $500 |
| 1 point | 0.25% | $1,000 |
| 1 1/2 points | 0.375% | $1,500 |
| 2 points | 0.5% | $2,000 |
| 2 1/2 points | 0.625% | $2,500 |
| 3 points | 0.75% | $3,000 |
To illustrate how the monthly payment and total interest are calculated, let's break down the example using a $300,000 mortgage with a 7.5% annual interest rate over a 30-year term:
- Principal Loan Amount (P): $300,000
- Annual Interest Rate: 7.5% (0.075 as a decimal)
- Monthly Interest Rate (r): 0.075 / 12 = 0.00625
- Loan Term (n): 30 years = 360 months
Using the mortgage payment formula: M – P x r x (1+r)ⁿ /((1 + r)ⁿ - 1)
- M = 300,000 x 0.00625 x (1 + 0.00625)360 / ((1 + 0.00625)360 – 1)
- M = 300,000 x 0.00625 x 8.245 / (8.245 – 1)
- M = 300,000 x 0.00625 x 8.245 / 7.245
- M = 2, 097.64
The monthly payment is approximately $2,097.64.
Over the life of the loan, the total payment is: Total Payment = M x n – 2,097.64 x 360 = $755,151.67
The total interest paid is: Total Interest = Total Payment – P = 755,151.67 − 300,000 = $455,151.67
Using that example, buying one point would give you a new interest rate of 7.25% and an upfront cost of $3,000. After buying the point, you’d pay $2,046.53 monthly and $436,750.38 in interest over the loan term. You’d save about $51 a month and roughly $18,401 in total interest.
To determine these savings, a standard mortgage payment formula is used, which accounts for the reduced interest rate, loan amount, and loan term.
The calculations above are for illustrative purposes only and reflect principal and interest payments based on the stated interest rate. They do not include other potential costs such as lender fees, closing costs, escrowed taxes and insurance, or prepayment penalties. The actual cost of borrowing may be higher and is best reflected by the Annual Percentage Rate (APR), which incorporates these additional charges. Always review your loan documents carefully and consult with a qualified mortgage professional to fully understand the financial impacts and obligations associated with your mortgage.
It’s also important to note that some lenders may also allow you to buy half points, which would lower your interest rate by 0.125%.
Curious about what your monthly payments might look like with (or without) buying mortgage points? Give this mortgage calculator a try.
What is the break-even point?
The break-even point is an important concept when you’re considering whether to buy mortgage discount points. To reiterate, mortgage points allow you to pay an upfront fee to lower your loan's interest rate, potentially saving you money over time. However, the upfront cost means it takes time to recoup your investment through monthly savings.
To calculate the break-even point, divide the cost of the points by the monthly savings they provide. It is important to note that if you sell, refinance, or otherwise pay off your mortgage before reaching the break-even point, you may not recover the upfront cost of the points.
For example, if buying points costs $2,000 and reduces your monthly payment by $50, your break-even point would be 40 months ($2,000 ÷ $50). If you plan to stay in your home beyond this period, buying points could be a smart financial move. If not, you may not recover the upfront cost.
Understanding the break-even point is especially important in today’s economy because of fluctuating interest rates and potential coverage gaps. Carefully evaluate your financial goals, how long you plan to stay in the home and current market conditions to determine if buying points aligns with your strategy.
How mortgage points work for adjustable vs. fixed-rate mortgages
Mortgage points work the same regardless of whether you have an adjustable or fixed-rate mortgage.
However, if you have an adjustable rate mortgage (ARM), your interest rate will change after the fixed period, generally five or seven years. Mortgage points may only apply to the initial fixed-rate period of an ARM. Please consult your lender for details.
Before you decide, calculate how long it will take for buying points on the mortgage to be worth the overall investment.
Pros and cons of buying mortgage points
Deciding whether or not to purchase mortgage points can be a tough decision because of the upfront costs. Here are some advantages and disadvantages to keep in mind.
Pros
- Lower monthly payments: Purchasing discount points can significantly lower your monthly mortgage payment, which can translate into greater financial flexibility.
- Save on interest over the loan: Lowering the interest rate will significantly reduce the amount of interest you pay over the life of the loan. If you stay in the home past the break-even point, you can gain significant savings.
- Seller can pay for them: In buyer’s markets, it’s possible for a seller to purchase discount points to entice a buyer to purchase the property. Seller tactics like these are referred to as seller concessions. Seller concessions are subject to lender guidelines and may vary.
Cons
- Upfront cost: You need to purchase mortgage points upfront, which can be challenging for some homebuyers to do on top of the down payment and closing costs.
- Takes time to return value: If you refinance or sell the home before you hit the break-even point, you could end up costing yourself more than you saved by purchasing the discount points.
If market rates are already low, say 3.5% versus 3.25%, paying for a slight reduction may not yield significant savings. Instead, you could focus on finding favorable loan terms without additional costs.
In summary
If you can afford to put down more money during closing and intend to stay in your home for a long time, mortgage points could potentially help you save a decent amount of money on interest.
Speak with a Home Lending Advisor today to see what option works for you.
