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When you take out a mortgage, your lender offers you an interest rate based on several factors, including market rates and your credit profile.
Lenders also offer you the opportunity to pay for a lower your mortgage rate by buying mortgage points, sometimes called “discount points.”
Points are priced as a percentage of your mortgage cost. Each point you buy reduces your interest rate by a certain amount that will vary by lender. Buying points makes financial sense when you stay in your home long enough, because you can save more on interest over time than you paid for the point.
Keep reading to learn how mortgage points work so that you can decide if buying points makes sense for you.
How do mortgage points work?
During closing on your mortgage loan, your lender may offer you the opportunity to reduce your interest rate by buying mortgage points. Each mortgage point costs 1% of the amount you’re borrowing. If you borrow $100,000, a point costs $1,000. If you borrow $200,000, it will cost $2,000. You pay this fee during closing, so points increase the upfront cost of buying a home. You may even be able to buy just part of a point, such as a ½ point for $500 or ¾ of a point for $750 on a $100,000 loan.
Every point — or part of a point — reduces your interest rate by a specific amount that varies by lender. For example, if your lender offers a 0.25% interest rate reduction for each point you purchase on a loan with an initial interest rate of 4.25%, buying one point would bring your interest rate down to 4%.
Points are listed on your loan estimate, as well as on Page 2, Section A of your closing disclosure. Any points listed on these documents must be connected to a reduction in your mortgage interest rate.
Take note: Some lenders also refer to other fees and upfront costs as points, but the points on your loan estimate and your closing disclosure must be discount points connected to a discounted interest rate.
Should you buy mortgage points?
Whether you should buy points depends mostly on how long you plan to stay in the home.
Points can cost thousands of dollars upfront, adding to the cost of getting your mortgage. But because your interest rate is reduced, the money you save on monthly payments can eventually make up for the initial cost. After you’ve covered the cost of the points you paid at closing, all additional savings from the lower interest rate is extra cash in your pocket.
To figure out if buying points makes sense for you, calculate how long it will take you to cover the upfront cost based on how much you might save.
Say you want to borrow $200,000 for a house, with the upfront cost of a point at $2,000. Divide $2,000 by the amount you save each month thanks to reducing your interest rate to see how many monthly payments it will take for you to break even.
Since the specific amount you save varies based on your lender, you’d need to calculate what your rate — and monthly payment — would be both with points and without. Let’s look at an example.
Doing the math
Let’s take the $200,000 you want to borrow for a home. If you get approved for a 30-year mortgage at 4.25%, your monthly payment to the principal and interest would be $984.
- One point: If you bought one point for a discount of 0.25 of a percentage point, you’d reduce your rate to 4%.
- Monthly savings: Your monthly payment would be lowered from $984 to $955, saving you $29 a month.
- Breaking even: Divide the point cost by your monthly savings ($2,000/$29 = 69 months). It would take you nearly six years to break even on the money you spent upfront to buy the point.
- Four points: If you bought four points to get a discount of 1 percentage point, you’d reduce your rate to 3.25%.
- Monthly savings: Your monthly payment would be lowered from $984 to $870, saving you $114 a month.
- Breaking even: Divide the point cost by your monthly savings ($8,000/$114 = 70 months). Again, it would take you almost six years to break even.
In these examples, you’d need to stay in your home for 69 months or longer to cover the cost of the points you buy and start saving money on your mortgage.
It’s hard to predict how long you’ll stay in your house. After all, life happens. But try to pin down a realistic estimate so that you’ll have a better chance of making the right decision about whether to buy points.
Comparing mortgage loan offers
Understanding how points work is just one important factor in your decision. It’s also important to know how they work when comparing loan rates. That’s because if two lenders offer you the same interest rate but one is charging a point and the other isn’t, the lender that isn’t charging the point is offering a better deal.
While you’re loan shopping, if two lenders offer you a fixed-rate loan of $200,000 at 4.25%, but one is charging a point for that rate, you’d be paying an extra $2,000 upfront with that lender to get the same rate from the other lender for free. That’s why it’s so important to comparison shop carefully and understand loan terms before you decide on a lender’s offer.
Mortgage discount points allow you to reduce your interest rate by essentially prepaying interest upfront. Each point you buy is priced at 1% of the amount you’re borrowing. Buying points can save you money on interest over time, but only if you stay in the home long enough for the discounted interest rate to make up for the upfront cost of points. Do the math to find out if buying points is the right choice for you when you get a mortgage loan.