What are mortgage points?
Mortgage points are also called “discount points.” Put simply, they’re fees paid to the lender at closing in exchange for a discounted interest rate.
It goes without saying that lower monthly payments can add up to major savings over time. It’s just a matter of doing the math to see if it makes sense for you.
How do mortgage points work?
They call it “buying mortgage points,” but what you’re actually doing is pre-paying some of the interest to get a better deal. This can help your monthly budget, sure—but it can really pay off over the life of a loan. This is where timing comes into play.
How much can you save by paying for mortgage points?
It depends on your loan terms, but you can potentially save quite a lot. Typically, each point reduces your interest rate by about 0.25%. For example, if you qualify for a 5.5% interest rate, buying one point brings it down to 5.25%.
You’ll definitely want to look at the big picture before making any decisions. If you're planning to stay put for a while, the savings can really add up. If you’re more of a nomad or planning to refinance, mortgage points may not be the way to go. We’ll explain why in just a bit.
Your actual savings will depend on the following:
- Loan amount: The larger your mortgage, the larger your savings may be because the savings are a percentage of your loan amount.
- Interest rate reduction: Each point typically lowers your interest rate by about 0.25%. This can shrink your monthly payments and overall interest paid.
- How long you keep the mortgage: The longer you keep your mortgage, the more helpful points can be. That’s because the upfront cost of points is spread out over more payments, maximizing your savings over time.
If you're planning to stay put for a while, the savings can really add up. If you’re more of a nomad or planning to refinance, mortgage points may not be the way to go.
How to calculate the break-even point
So, how can you tell if it’s worth it? To calculate your break-even point, you need to figure out when the savings from a lower interest rate will cover the cost of the points. The formula’s simple: just divide the cost of the points by how much you save each month.
Imagine that buying mortgage points costs you $2,000 and saves you $50 a month on mortgage payments. Your break-even would be $2,000 divided by $50, which equals 40 months. So, it would take 40 months to recoup the cost of the points. If you keep your roots planted for longer than that, buying mortgage points could be a good money move.
Should you buy down your interest rate with points?
Ultimately, it’s up to you, but here are some guidelines to help you decide:
If you're setting up camp for the long haul, splurging on points may make sense. You'll forfeit some cash up front, but the tradeoff is sweet: lower monthly payments and more money in your pocket over time.
But here's the catch: If you've got a case of wanderlust or you're eyeing a refinance in the near future, buying points might drain your wallet. Before you jump in, check out the current interest rate for your preferred loan type, crunch those numbers and make sure the cost of points doesn't overshadow the savings. It's all about timing and your ultimate financial goals.
Discount points vs. origination points
Not all points are created equal. As discussed, discount points are like prepaid interest that lowers your rate.
Origination points, however, do not reduce your interest rate. They’re fees that a lender charges (typically 1% of the loan amount) for processing your mortgage application and checking out your finances. Not all lenders charge these fees, and the rates do vary. However, lower fees may mean higher interest rates or additional charges. Keep an eye out for these fees as you shop around for a mortgage.