When you obtain a mortgage, your lender may charge “mortgage points.” What does this mean, and how can the concept be used to your advantage?
A single mortgage point is equal to one percent of the total mortgage amount. For example, a point associated with a $150,000 loan will be valued at $1,500.
Your lender may charge zero points, one point, or several points at closing. You may even be charged 1.5 or 2.5 points, which would be valued at $2,250 and $3,750 respectively for the same $150,000 loan.
Mortgage points can be used in several ways, sometimes to your advantage and other times to your distinct disadvantage.
Here are four things you need to know about mortgage points before signing any paperwork:
#1: Discount vs. Origination Points
There are two common types of mortgage points — discount and origination.
Discount points are used as prepaid interest on your mortgage loan. The more points you pay, the lower your interest rate. This is also called “buying down the rate.”
Most borrowers can pay anywhere from zero to several mortgage points, depending on their desire to lower their interest rate.
Origination points, on the other hand, are used to cover the lender’s cost of processing the loan. They are used as a simple and straightforward way to handle closing fees. These points are negotiable, though the number required by your lender may vary.
#2: When to Pay Discount Mortgage Points
Choosing to pay a discount mortgage point should depend on two things. First, the length of time you intend to stay in your home. Second, the amount of money you have on-hand at closing.
The longer you plan to stay in your home, the more sense a discount mortgage point investment makes. Paying more cash upfront translates to lower monthly payments. So, if you can benefit from those lower payments for years, the payment could be worth it.
Some math can help with this decision. For example, if you obtain a $200,000 loan with a 30-year mortgage period and a 5% interest rate, you’ll pay $1,074 per month for the next 30 years. That translates to $12,888 annually. Let’s assume you paid zero mortgage points upfront for this offer, covering only closing fees.
Now, let’s throw some mortgage points into the mix. Instead of accepting a 5% interest rate, you pay four mortgage points in exchange for a 4% rate. That means, in addition to closing costs, you’ll pay $8,000 upfront. In return, your monthly payments for the next 30 years will drop to $955. Annually, you’ll save $1,428.
Over the term of your loan, you’ll save $42,840, making the choice seem obvious. Except you have to consider the amount of time you’ll stick with your loan.
Did you know that only one-fifth of households own their home without a mortgage? The rest have chosen to move, refinance, or rent. If you intend to be one of these people, you need to think about your break-even point.
Under our current example, you’ll earn back your $8,000 investment in just under six years. If you intend to stay in your home for at least six years — the point at which you’ll break even — without refinancing or otherwise changing your loan, you’ll begin to reap the rewards of your mortgage point investment.
Of course, the longer you stay, the more your initial investment will pay off.
#3: Rebate or Negative Points
What happens if, at closing, you can’t afford to pay the origination points required by your lender? At this point, the time has come to consider rebate or negative mortgage points — a term often used when describing a no-cost mortgage.
These mortgage points are offered when borrowers don’t have much cash on-hand at closing. In exchange for a higher interest rate, your lender will remove points from your closing costs.
For example, if your lender requires four origination points at closing and you can only afford one, you might be given three rebate points in exchange for a 1% increase in your interest rate.
The credit given in negative points cannot exceed the mortgage closing costs, blocking borrowers from using extra points to provide a bigger down payment. In addition, negative points can’t be used to pay recurring fees like property tax.
#4: Other Important Facts
Here, we’ve listed a few last-minute facts you should know about mortgage points before making the leap:
- While you’ll receive an interest rate reduction for purchasing points, the number associated with this reduction is determined by the lender and marketplace you choose. Put simply, you won’t know your final rate until you meet with a lender.
- Because there are possible tax benefits to purchasing mortgage points, you should get in touch with a tax professional. This way, you’ll get the biggest bang for your buck.
- When the time comes to choose between making a down payment and buying points, don’t make a decision without running the numbers. A lower down payment could mean required private mortgage insurance (PMI) — which can end up being more expensive.
- For adjustable-rate mortgages, the discount offered on your loan interest rate may only apply during your first fixed-rate period. It’s important to ensure your break-even point comes before this period expires. Otherwise, you might be digging yourself a deep financial hole.
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