What Are Mortgage Points and How Do They Work?

When you’re shopping for a mortgage, you may come across the term “mortgage points.” While they may seem confusing at first, understanding what they are and how they work can help you make a more informed decision about your home loan.

What Are Mortgage Points?

Mortgage points are fees you can pay directly to your lender at closing in exchange for a lower interest rate on your mortgage. This process is often referred to as “buying down the rate.” Mortgage points are typically expressed as a percentage of the total loan amount, and there are two main types:

Discount Points. These are the most common type of mortgage points. They allow you to lower your interest rate in exchange for an upfront payment. Typically, one discount point equals 1% of your loan amount. For example, if you’re taking out a $200,000 loan, one point would cost you $2,000.
Origination Points. Unlike discount points, origination points don’t reduce your interest rate. Instead, they are fees charged by the lender to cover the costs of processing your loan. These points are essentially a way for the lender to get paid upfront for their services.

How Do Mortgage Points Affect Your Interest Rate?

The primary advantage of buying discount points is the ability to lower your mortgage’s interest rate. Here’s how it works:

Reducing Your Interest Rate. Each discount point you purchase typically reduces your interest rate by about 0.25%, although the exact reduction can vary depending on the lender and market conditions. For example, if your lender offers you a 6% interest rate on a 30-year mortgage, paying one point upfront might reduce that rate to 5.75%.
Calculating the Break-Even Point. One of the most important factors to consider when deciding whether to buy points is the break-even point. This is the time it takes for the savings from the reduced interest rate to equal the upfront cost of the points. If you plan to stay in your home longer than this break-even period, buying points could save you a significant amount of money over the life of your loan.

A Real-Life Example

Let’s say you’re considering a $200,000 mortgage with a 30-year fixed interest rate of 6%. If you decide to buy one discount point for $2,000, your interest rate might drop to 5.75%. While this reduction may seem small, it can result in substantial savings over time. With a lower interest rate, your monthly mortgage payments will be lower, and you’ll pay less in interest over the life of the loan.

Should You Buy Mortgage Points?

Before deciding whether to buy mortgage points, it’s important to weigh the benefits against the costs. Here are a few factors to consider:

Upfront Cost: Buying points requires an upfront payment, which might not be feasible for everyone, especially if you’re already stretching your budget to cover your down payment and closing costs.
Long-Term Savings. If you plan to stay in your home for a long time, the savings from a lower interest rate can outweigh the initial cost of the points. However, if you think you might move or refinance within a few years, the upfront cost may not be worth it.
Type of Loan. The type of loan you have can also impact whether buying points is a good idea. Points may be more beneficial for a fixed-rate mortgage, where the interest rate remains constant over time, compared to an adjustable-rate mortgage, where the rate may change.

Conclusion

Mortgage points can be a smart way to lower your interest rate and save money over the life of your loan, but they aren’t the right choice for everyone. By understanding what mortgage points are and how they work, you can make a more informed decision about whether buying points is the right move for you.

Before making a decision, it’s essential to talk to your lender and run the numbers to see if buying points makes sense for your specific situation. By understanding how mortgage points work, you can make a more informed decision that aligns with your financial goals.

Ready to explore your mortgage options? Contact us today to learn more about how you can save on your home loan.