What Are Mortgage Points and How Do They Work?

Navigating mortgages can feel complex, especially when juggling terms like "mortgage points." These points can significantly impact your loan's overall cost and monthly payments. Delving deeper into how mortgage points work reveals a financial tool that can be beneficial to your financial goals. With this knowledge, you can determine whether buying mortgage points makes sense for your situation.

What Are Mortgage Points?

By paying a set amount upfront, you can receive points on a mortgage loan. Each point lowers your interest rate, reducing your monthly payment and allowing you to save money on the loan over the long term.

A mortgage point is a one-time fee that is equivalent to 1% of the total loan. For example, for one point on a $100,000 loan, you’d pay $1,000. Two points would cost you $2,000. Each point typically lowers your interest rate by about 0.25%.

Buying mortgage points can be beneficial for borrowers planning to stay in their homes for an extended period, as the upfront investment in points can yield substantial savings over time.

It is important to note that mortgage points are distinct from origination points or fees, which are charges imposed by the lender for processing the loan.

How Mortgage Points Can Save You Money

Understanding the value of mortgage points and how they can positively impact your financial outlook is crucial when navigating home financing. Mortgage points can serve as great financial tools, allowing borrowers to strategically manage upfront costs and long-term savings. By paying a set amount upfront, borrowers can lower their interest rate, subsequently reducing their monthly mortgage payments and total interest paid over the life of the loan.

When you opt to buy points, you essentially make a tradeoff between your upfront costs and your long-term monthly payments.

Should You Take Points On A Mortgage?

Deciding whether to purchase mortgage points is a pivotal choice that hinges on various factors, including your current financial circumstances and your anticipated duration of homeownership.

If your timing is right and you don’t plan on moving or refinancing your loan before you reach the breakeven point, you may want to consider buying points to enjoy their benefits. Just remember, there are also disadvantages to buying points.

Mortgage Points: Benefits And When To Consider Them

• Lower mortgage rates: One of the primary benefits of mortgage points is that they can help borrowers secure a lower interest rate on their mortgage loan.
• Lower monthly payments: Reducing the interest rate on their loan, resulting in lower monthly mortgage payments and significant long-term savings.
• Less interest paid over the life of loan: With less interest charged, the total interest paid throughout the life of the loan will be lower.
• May be used in negotiations: In certain situations, especially a buyer’s market, buyers may be able to get the seller to pay for their points.

Mortgage Points: Drawbacks And When To Avoid Them

• Upfront costs: Using mortgage points typically increases the closing costs of a house, which are typically paid out-of-pocket by the borrower. And if you plan on refinancing your mortgage soon, you’ll pay closing costs for the new loan, which means you end up paying for the same things twice.
• Takes away from down payment: It may be better to apply any extra cash to your down payment than to points. A larger down payment may result in a lower interest rate, cheaper mortgage insurance (or no mortgage insurance) and/or lower monthly mortgage payments.
• Must hit breakeven point for benefits: It takes a few years for the money you save on interest to offset the cost of the points. If you know you’ll be moving soon, mortgage points may not be worth the expense.
• High costs: While mortgage points offer potential benefits, borrowers may want to avoid them if they’re already burdened by upfront costs. Individuals with limited financial flexibility may find the higher upfront costs of mortgage points restrictive.

Borrowers should carefully assess the financial situation, long-term housing plans and overall affordability before deciding whether to purchase mortgage points. Consulting with a financial advisor or mortgage professional can provide personalized guidance tailored to individual circumstances and goals.

Mortgage Point FAQs

What are discount points on a mortgage?

Discount points, also known as mortgage points – or simply "points" – are upfront fees paid to the lender at the time of closing in exchange for a lower interest rate on the mortgage loan. Each discount point typically costs 1% of the total loan amount and typically reduces the interest rate by about 0.25%. By paying discount points, borrowers can effectively "buy down" their interest rate, resulting in lower monthly mortgage payments over the life of the loan.

What’s the difference between discount points and origination points?

The primary difference between discount points and origination points lies in their purpose and allocation. Discount points are fees paid upfront to lower the interest rate on the mortgage loan, effectively reducing the monthly payments over the loan term. On the other hand, origination points are fees charged by the lender for processing the loan, covering administrative costs and facilitating the loan origination process. While discount points directly impact the interest rate, origination points are separate fees unrelated to the interest rate but contribute to the overall closing costs of the mortgage.

How much is one point on a mortgage?

One point on a mortgage typically costs 1% of the total loan amount. For example, on a $300,000 mortgage, one point would cost $3,000. In exchange for paying one point upfront, borrowers can typically lower their interest rate by about 0.25%. This reduction in the interest rate can result in significant savings over the life of the loan, making mortgage points a strategic option for certain borrowers.

Is it better to pay points or a higher interest rate?

Whether it's better to pay points or accept a higher interest rate depends on various factors, including your financial goals, time horizon and available funds. Paying points upfront can result in lower monthly payments and long-term interest savings, making it advantageous for borrowers who plan to stay in their homes for an extended period. Conversely, opting for a higher interest rate may be preferable for those with limited upfront funds or who plan to sell or refinance their homes relatively soon. It's essential to weigh the upfront costs against the potential long-term savings to determine the most suitable option for your specific circumstances.

The Bottom Line

Understanding mortgage points is pivotal in navigating home financing. While mortgage points offer significant benefits, it's essential to consider factors such as upfront costs, anticipated duration of homeownership and current financial circumstances before deciding whether to buy points.

Consulting with a financial advisor or mortgage professional can provide tailored guidance to help you make informed decisions in your home buying journey. Take the first step toward homeownership today by exploring what kind of mortgage you qualify for today.