Mortgage Points Explained — How it may save you money
by Edward Galstyan
So what are mortgage points, exactly?
Mortgage points are sold by the lender when purchasing a house. Mortgage points are also called discount points. The purpose of purchasing mortgage points is to reduce the fixed APR on your loan. For each point you pay up-front, you obtain a lower interest rate. Essentially, purchasing mortgage points is paying interest up-front which then results in a lower interest rate in the long run. The general rule is paying one point results in .125% rate reduction or 1/8th of the overall mortgage rate. Multiple mortgage points may be purchased, depending on the lender.
How much does it cost to purchase mortgage points?
A single point purchase costs 1% of the value of the amount you borrow to purchase a house.
Example 1: You purchase a house for $200,000 and put a 20% down ($40,000) and finance $160,000. The cost for a single point purchase on this transaction would be $1,600 ($160,000 x 1.00%)
Should I purchase mortgage points and is it really worth it?
There are a number of situations which must be considered before purchasing mortgage points.
1.) Whether you can afford to make the upfront payment required to purchase mortgage points. Mortgage points are paid up-front with the closing costs.
2.) The length of time you expect to have the mortgage. Remember, the purpose of purchasing mortgage points is to pay points up-front, which essentially is interest up-front, to save money on interest in the long run. It is a rate buy down option.
Example 2: You purchased a house in example 1 and financed $140,000. Your lender offers you a hypothetical rate of 6.00% fixed over a 30 year period. Your lender also has an option for you to purchase one point (costing $1,400 upfront) but as a result of the point purchase they offer to lower your 30 year fixed interest rate down to 4.875% (the standard 0.125% discount for purchasing a point applied)
The length you expect to have the mortgage matters because in the long run you will save money. You must figure out the break even point.
Let’s say you get an interest rate of 6% on that $140,000 loan. Your monthly payment for principal and interest would be $839.37. If you were to purchase 1 points at the cost of $1,400 that would lower your interest rate slightly to about 5.875% and your monthly payment would then be $828.15 per month, a monthly savings of $11.22.
Now you can use that scenario to determine your break-even point to determine if purchasing points is worth it. First we need to find out how long it will take before you get a return on your initial point purchase. In the example above, you would need to keep that mortgage for at least 125 months or 10 years, 3 months to get your money back. (cost of upfront points DIVIDED by monthly savings EQUALS length to keep loan). Thereafter, you continue to save the $11.22 each and every month because you purchased a point up front.
Also keep in mind that if you refinance ahead of the break-even point, you will lose out since you are getting a new mortgage with refinancing.
Do some planning and calculating to determine if purchasing mortgage points is right for you and it may save you some money — in the long run.
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