Mortgage Points: Are They Worth It?

A home is one of the biggest investments most people will ever make, so it’s no surprise buyers look for ways to lower costs as much as possible. One way to save in the long run is to lower the interest rate on your loan, which you can do by purchasing mortgage points.

When you buy points, you pay money at closing to lock in a lower interest rate. While you pay more upfront, you could end up saving thousands of dollars in interest payments over the life of the loan.

But are points worth it? Maybe, depending on your situation. Understanding what mortgage points are and how they work will help you determine whether it’s the right strategy for you.

Mortgage points — also known as mortgage discount points — help borrowers save money by reducing the interest rate on their home loan. This lowers their monthly payment and the total amount of interest they’ll pay on the loan. This is especially beneficial to homeowners keeping their mortgage for a long time. Each point costs 1% of the total loan amount and is paid directly to the mortgage lender at closing.

Origination Points Vs. Mortgage Discount Points

As you go through the lending process, your lender may require origination points. Origination points are the fees home buyers pay for the lender to originate and process their home loan.

In comparison, mortgage points are an optional fee you pay to obtain a lower interest rate.

While mortgage points typically cost 1% of the loan amount for each point you buy, origination points typically cost around 0.5% – 1% of the total loan amount.

Keep in mind that not all lenders charge the same origination fees. It’s important to compare your options among different lenders.

When you close on your mortgage, you have the option to buy mortgage points in exchange for a lower interest rate. Each point costs 1% of your total home loan, so the more you borrow, the more you’ll have to pay for mortgage points.

And since you buy mortgage points at closing, this will raise the upfront cost of purchasing a home. However, you’ll earn a lower interest rate which will lower your monthly payment and could end up saving you money over the life of the loan.

Each mortgage point reduces your interest rate by a certain amount. For instance, some lenders offer a 0.25% interest rate reduction for each point purchased. So, if your original interest rate is 5.25%, buying one mortgage point will lower your rate to 5%.

Example Of How Much Mortgage Points Save You

Here’s an example of how mortgage points work. Let’s say you’re purchasing a $350,000 home at a fixed rate of 5.25%. The following table shows you what you can expect to pay on a 30-year loan term. Keep in mind, taxes and insurance are not included in the monthly payment.

If you choose not to purchase mortgage points, you won’t be out any additional money for points at closing. But you will end up paying more on your monthly mortgage payment and will pay more in interest over the life of the loan.

Whether mortgage points are a good idea depends on your current financial situation and how long you plan to live in your home. Here are a few things you should consider before buying mortgage points.

When To Consider Buying Mortgage Points

Buying mortgage points may be worth it if you plan to live in the house for a long time. The first place to start is to calculate your breakeven point. This is the point in the loan that you’ll recoup in savings the money you spent upfront.

Using the above example, let’s say you bought one mortgage point for $3,500. That means you’ll save $53.83 on your monthly payment. To calculate your breakeven point, you’ll divide the monthly savings from the money you spent on mortgage payments:

$3,500 / $53.83 = 65 months

That means you’ll need to stay in the home for over 5 years to breakeven on the points you bought. If you plan to sell before then, buying mortgage points probably isn’t worth it.

When Not To Buy Mortgage Points

When you buy mortgage points, this payment doesn’t count toward your down payment or any other fee you have to pay at closing. If you’re already concerned about being able to pay your closing costs, adding mortgage points on top of that may not make sense.

It also doesn’t make sense to buy mortgage points if you plan to sell the home or refinance within a few years. You won’t hold the mortgage long enough to reap the benefits of buying the lower interest rate.

In certain situations, buying mortgage points can make sense. For instance, if you plan to stay in your home for a long time, you’ll end up recouping your upfront costs. In other cases, the cons may outweigh the advantages.

Pros

• You’ll earn a lower rate on your mortgage.
• Your monthly payment will be lower after the mortgage points are applied.
• You’ll save money on your mortgage over time. It’s helpful to calculate your breakeven point before buying points.
• You may be able to negotiate with the seller to get them to pay for the mortgage points.
• Since points are prepaid interest, they’re tax-deductible for anyone who itemizes their deductions.

Cons

• You’ll have higher upfront costs when you close on your mortgage.
• Mortgage points may not make sense if you don’t plan to stay in the home for a long time.
• If you sell or refinance before the breakeven point, you won’t end up saving any money.

If you’re in the process of buying your dream home that you plan to live in for more than 10 – 20 years, buying mortgage points may be a good strategy. When you purchase mortgage points, you pay a one-time fee at closing for a lower interest rate.

Make sure you know what your breakeven number is before buying mortgage points. This will help you determine whether it’s a worthwhile investment for you.

Buying a home is a big financial decision and it’s important to plan carefully and understand the type of home you can afford. A knowledgeable home loan expert can help you understand the ins and outs of the process and buy a home with confidence.