A house is the most expensive purchase most of us will ever make, so naturally, anything that can that can reduce the cost of a mortgage is worth looking at. Besides negotiating a good price and shopping for the best priced home, some homebuyers buy down mortgage points.
So, what are mortgage points? How do they work? And is this method right for you?
They are also called “discount points,” they’re basically a way to lower your interest rate – for a cost or a “fee”
We are going to look more closely at mortgage points today, how they work, and when it’s best to use them.
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 sometimes called “buying down the rate”
Each point the borrower buys costs 1 percent of the mortgage amount. So, one point on a $300,000 loan would cost $3,000
Mortgage points are a type of prepaid interest. By buying these points, you reduce the interest rate of your loan, typically by 0.25 percent per point. You can often buy a fraction of a point or up to as many as three whole points — sometimes even more.
Discount Points vs Origination Points
· Origination points will not affect the interest rate on your loan, and they are not discretionary, but mandatory.
· They are fees charged by a lender to originate, review and process your loan.
· Like its discount point cousin, one origination point typically equals 1 percent of the total mortgage.
· So, if a lender charges 1.5 origination points on a $300,000 mortgage, the borrower must pay $4,500.
· Typically, you pay your origination points as part of your closing costs when you settle and sign for your new home purchase, with Title & Escrow.
How do Mortgage points work?
· Each mortgage discount point typically lowers your loan’s interest rate by 0.25 percent
· One point would lower a mortgage rate of 7 percent to 6.75 percent for the life of the loan.
· How much each point lowers the rate varies among lenders.
· The rate-reducing power of mortgage points also depends on the type of mortgage loan and the overall interest rate environment.
· When you explore buying points, mortgage lenders should share with you the specifics of what their company is offering.
· Borrowers can buy more than one point, and even purchase 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
· Borrowers receive a loan estimate document after they apply for a mortgage,
· Borrowers also receive this from Title & Escrow as part of the closing disclosure.
Should you buy points?
Buying mortgage points is a way to pay upfront to lower the overall cost of your loan and reduce your monthly payment. It makes the most sense in these cases:
1. First if you plan to live in your home for a long period of time…
a. Because buying points on mortgage loans reduces the rate for the life of the loan,
b. Every dollar you spend on points goes further the longer you pay that mortgage.
c. As a result, if you plan to be in the house for a while, the amount you’ll save each month is likely to make the upfront cost worth it.
d. Conversely, if you don’t plan to stay in a home for a long time, paying points is likely to lose you money overall.
2. Second if you have 20% down. If you have 20% down you’re avoiding private mortgage insurance (PMI) and likely getting the best interest rate the lender can offer you.
3. If you haven’t hit the 20 percent mark on the down payment, though, putting money there rather than into points will likely still lower your interest rate, and possibly by a larger margin. That’s because bigger down payment lowers your loan-to-value ratio or LTV, which is the size of your mortgage compared with the
4. Even if you plan to stay in the house for a while, the current environment of relatively high interest rates may have you considering a refi down the road.
a. Refinancing will change your mortgage interest rate, so if you think that could be in your future, it may be best to skip buying points mortgage-wise
Borrowers should consider all the factors that could determine how long they plan to stay in the home with that mortgage — such as
· the size and location of the property,
· their job situation and
· the current mortgage rate environment —
· then figure out how long it would take them to break even before buying mortgage points. – there are mortgage calculators that you can find online that include using mortgage points to figure how much this could save your.
Example of How mortgage points can cut interest
Say your mortgage interest rate is 6.75% and your mortgage is $300,000 and you want your mortgage interest rate to be 6%... it will cost $9,000 to buy the interest down to 6%. This is the BIG question – would you be better off using that $9000 towards down payment and have a smaller mortgage or have the higher mortgage and put that $9000 towards buying points.
By reducing the loan’s interest rate, you can effectively lower your monthly payment. However, this requires an upfront payment. Again, the longer you plan to live in a home, the more benefit you’ll get from paying for points. (see chart)
If you can afford to buy discount points on top of the down payment and closing costs. you will lower your monthly mortgage payments and could save lots of money. The key is staying in the home long enough to recoup the prepaid interest. As we mentioned before, if you sell the home after only a few years, or refinance the mortgage or pay it off, buying discount points could be a money loser.
The other thing that borrowers are doing is asking the Seller to contribute to their closing costs and prepaids so that this can go towards a Buyer’s purchasing mortgage points.
Compare loans with APR
Looking at the annual percentage rate (APR) of your mortgage can help you compare loans with different rate and point combinations. The APR incorporates not just the interest rate, but also the points you pay and any fees the lender will charge, so it can give you more clarity and let you more easily compare apples to apples
You can decide whether to pay points on a mortgage based on whether this strategy makes sense for your specific situation. Once you get a quote from a lender, run the numbers to see if it’s worth paying points to lower the rate for the length of your
As you set out on your home search, it is important to know the following:
· What kind of home you want and can afford
· How much your monthly payments will be
· How much you need to save for a down payment
View affordability from two perspectives:
1. Your overall monthly payments which included household expenses, mortgage payment, home insurance, property taxes, auto loans and any other financial considerations
2. How lenders determine what you can afford. Just like lenders, our Affordability Calculator looks at your Debt-to-Income Ratio (DTI) to determine what home price you can afford.