What’s the "Point"? An Overview of Mortgage Points (and How They Can Save You Money)
If you’re a first-time home buyer or a renter like me, you may have heard of mortgage points, but you may not have any idea what they’re for, whether you should take advantage of them, or who to ask. A mortgage consultant or even your Realtor will be able to give you more detailed information on mortgage points, but in the meantime here’s our super-basic guide.
Discount Points vs. Origination Points
There are two basic types of mortgage points, discount points and origination points. We’re mainly taking a look at discount points, but here's a quick look at both:
- Discount Points – these are points purchased by the borrower to lower the interest rate of the loan (a “mortgage buydown”), and thus, lower monthly payments. They are usually tax-deductible.
- Origination Points – this is the fee associated with the origination of the loan and is used to compensate the loan officer and process the loan. These vary by lender as well as by the borrower’s financial situation and are not usually tax-deductible.
Okay, so what do you mean by “point”?
A “point” in the mortgage world refers to 1 percent of the original loan. So, if you’re talking about a home loan for $350,000, a point would equal $3,500. If the loan is for $90,000, a point would equal $900 and so on.
Buying a discount point means to pay the 1 percent of the total loan. Doing this can lower your interest rate, and thus, your monthly mortgage payments.
Typically, one point will reduce a fixed-rate loan by .125 percent and an adjustable-rate loan by .25 or .375. You should talk to your lender about what options are available for your specific home loan situation. Some websites advise using a .25 buydown rate as a general rule for figuring out your monthly payment reduction.
“As a rule of thumb, the mortgage's interest rate is reduced by a quarter of a percentage point for every discount point you pay. That's just a rough guide, though; the actual amount of the discount varies by lender and can fluctuate in response to movements in the bond markets. One day a lender might drop the interest rate by a quarter-point in exchange for a discount point; the next day, the same rate reduction might cost only half a point. Most lenders give the option of paying anywhere from half a point to four discount points or even more.” (BankRate)
How do I know if buying discount points is right for me?
In general, if the rate is a lot higher than you can afford, then you should shop for a different loan or look at a cheaper home for sale. Buying discount points pays off if you’re in the home for a long time.
If you are planning to stay in your home for 5-10 years, and the rate is just a little higher than you’d like it, then discount points are well worth your consideration.
Now for the math.
- Figure out how much buying a point would reduce your loan’s interest rate.
- Calculate your monthly payments based on your current rate without points.
- Calculate your monthly payments based on the lower rate with points.
- Subtract the lower amount from the higher amount to determine your monthly savings.
- Divide the cost of the points by the monthly savings to determine how many months you would need to break even.
- Decide if it’s worth it.
For example, let’s say my home loan is for $300,000 at an interest rate of 6 percent. I’d like to lower the interest rate to 5.5 percent, so I need to buy 2 points; in other words, pony up an additional $6,000.
According to this online mortgage calculator, my monthly payment without points will be $1,762, and my monthly payment with points will be $1,703.
The difference is $59 a month.
The points cost me $6,000, so it would take me over 100 months to break even – that’s over 8 years!
So if I was sure (as sure as one can be) that I was putting down roots and not planning to pick up and move AND I had the funds on hand to purchase points, this might be worth it. Then again, it might not.
Buying discount points can definitely result in big savings for the right person – be sure to talk to your lender, a mortgage consultant, or your ZipRealty Realtor for more advice on how to finance your home. And try out our mortgage calculators, too!
- Buyers: Preapproved or Prequalified? We Tell You Which One You Really Need
- The Skinny on Down Payments
- Tax Planning for Next Year
Sarah Louise Green lives in the San Francisco Bay Area and writes about national real estate trends, home financing, advice for buyers, and DIY projects for the home and garden. Follow Sarah on Twitter:@slouisegreen