Mortgage Points Made Simple

Paying Points on a Home Loan

A point is one percent of the total mortgage loan amount - a fee or cost incurred by the borrower in a loan transaction. By paying points (loan discount points),  borrowers can get a lower interest rate then lenders would otherwise offer. Points allow you to pay less each month on your new home mortgage, by paying a little bit more upfront. Borrowers pay points to “buy down” the interest rate which ultimately reduces the long-term interest on the loan.

Is Paying Points An Option? - It’s possible to take out a mortgage loan without paying points. If borrowers are short on cash for their new home purchase or not planning to own the home for long, not paying points would be an option.  For many home buyers, obtaining a lowered interest rate - by paying some points upfront - is worth it.

Rate-Point Combinations - What’s confusing to loan shoppers is that lenders have different combinations of rates and points available.  Is a 7% loan with 3 points better that an 7.5% loan without points? If you consider that each point is worth about 1/8 to 1/4% drop in interest rate, the two are comparable. Yet, depending on the new home buyer’s circumstances, one will be a better fit than the other.

Compare Options With A Mortgage Calculator - Let’s say you pay 3 points ($3000) for a 7% rate on a $100,000, 30 year mortgage - Your interest and principal payments would be approximately $408 lower per year than a 7.5% loan with no points. For your savings to pay back the $3000 points expense, you would have to own the home a little over 7 years. Try running the numbers on an online mortgage calculator like the easy-to-navigate one on Bankrate.com.

Keep in mind, that if you move before the seven years, you will lose more money in points than you will have saved with the lower rate loan.  The investment’s rate of return is what will really matters - whether you win or lose with this strategy.

Points Over Time -  How much of a drop in interest rate your points can buy will determine how long you’ll need to own the home to recoup your costs. For example, if 3 points buy a 3/4% drop in interest rate, it would take five years to recoup your costs. But if you were to hang on to the home for the entire length of a 30 year mortgage, you’d save over $12,000.

Wanting To Pay Points But Short On Cash - If you want to pay points but don’t have enough cash, it’s possible to roll the points into your mortgage loan. You would finance  $103,000 -instead of $100,000 (using our previous example) - at the rate of 7%. By doing this, your mortgage costs would increase $240 - compared to paying cash for the points at closing (settlement). What’s important to note is that your mortgage would cost $168 less a year than if you didn’t pay points and took the 7.5% rate.

Although each borrower’s financial picture is unique, choosing to pay points when obtaining a mortgage for your new home, can be seen as an investment that yields a return - increasing the longer you keep the home. You’ll save in the monthly payment - due to the lower interest rate - in addition to the lower loan balance in the month the loan is paid off.

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