Mortgage points are the fees a borrower pays a mortgage lender in order to trim the interest rate on the loan, thus lowering the overall amount of interest they pay over the mortgage term. This practice is what is said to be buying down the rate.
Each point the borrower buys costs a minimal 1 percent of the mortgage amount. So, one point on a $300,000 mortgage would cost about $3,000.
To this effect, mortgage points is a type of prepaid interest. By buying these points, it will help you reduce the interest rates on your loan, which can be about 0.25 percent per point.
You can also buy a fraction of a point or up to as many as three points and more.
However, by reducing the loan’s interest rate, you therefore, lower your monthly payment. However, keep in mind that this requires payment. The longer you plan to live in a home, the more benefit you will enjoy and get from paying for points.
Discount Points vs Origination Points
Mortgage points that can lower your interest rate, otherwise called discount points, are not to confuse you to be origination points which is another type of mortgage point.
Well as a First Time Mortgage Buyer: Preparation and Tips on Home Purchasing you have to read this post through.
Origination points do not in any way affect the interest rate on your loan. They are not discretionary, but mandatory and very necessary.
They are fees, your lender charges to originate, review and process your loan application.
Just Like its discount cousin, one origination point typically equals a percent of the total mortgage. Therefore, if a lender charges 1.5 origination points on a $250,000 mortgage, the borrower must pay $3,750.
When you pay your origination points as part of your closing costs, you are finalizing your home purchase.
Furthermore, not all lenders charge origination points on their mortgages. While some lenders allow borrowers to get a loan with no- or reduced-closing costs or origination points; however, they often compensate for that with higher interest rates or hike in other fees.
You can also sometimes negotiate origination points. Homebuyers who come to the table with a 20 percent down payment and a strong credit score have the most significant negotiating power, as lenders will automatically reduce origination points to entice other qualified buyers.
How do Mortgage Points Work?
Each mortgage discount point lowers your loan interest rate by 0.25 percent, so one point would lower a mortgage rate of 4 percent to 3.75 percent for the life of the loan.
How much each point lowers the rate varies among lenders, however. The rate of reducing power of mortgage points also solely depends on the type of mortgage loan and the total interest rate at the time.
When you want to buy points, ask mortgage lenders to know the specifics of the mortgage. Read Also: 30-Year Fixed Mortgage Rates.
Borrowers can buy more than one point, and even fractions of a point. A half-point on a $300,000 mortgage, for example, would cost $1,500 and lower the mortgage rate by about 0.125 percent.
The points are paid at closing and listed on the loan estimate document, which borrowers receive after they apply for a mortgage, and the closing disclosure, which borrowers receive a few days before the closing of the loan. This brings us to the question of should you buy down your interest rate?
Should you buy down your interest rate?
Buying mortgage points is a way to pay upfront to lower the overall cost of your loan and reduce its monthly payment. It makes the most sense in a few cases. Let me show you a few of these cases:
- If You Plan on Staying in The Home for a Long Period of Time: As you already know, buying points on mortgage loans reduces the rate for the life of the loan. This is because every dollar you spend on points goes further the longer you pay that mortgage. As a result of this, if you have intentions of being in the house for a while, the savings for each month is likely to make the advance pay worth it. It may take several years to break even with the advance payments.
- You Are Already Putting 20 Percent Down: If you have not hit the 20 percent mark on the down payment, though, putting money there rather than into points will lower your interest rates. It will possibly buy a larger margin. This is because bigger down payment lowers your loan-to-value ratio, which is the size of your mortgage in comparison with the value of the home.
- You don’t plan to refinance anytime soon. Even if you plan to stay in the house for a while, the current strain of relatively high interest rates may have you considering a refinance down the road. Refinancing will change your mortgage interest rate, so if you think that may be part of the future, it may be prudent to skip buying points mortgage-wise now.
Ultimately, borrowers have to put into careful consideration, all the factors that could determine how long they plan to stay in the home.
How Much Can You Save by Paying Mortgage Points?
Let’s say you can afford to buy discount points on top of the down payment and closing costs, you will lower your monthly mortgage payments and save lots of money.
The key is to stay in the home long enough to recover the prepaid interest. But if you sell the home after only a few years, or refinance the mortgage or pay it off, buying discount points can be a money-loosing venture.