Mortgage Points: What They Are and How They Work

Mortgage points, also known as loan discount points or discount points, are a type of upfront fee paid to a mortgage lender at closing. Each point is equal to 1% of the loan amount. For example, if you have a loan amount of $200,000, one point would cost $2,000.

Table of Contents

Introduction

Points are typically paid at closing, but they can also be financed into the loan. When points are financed, the cost is added to the loan amount and you pay interest on the points over the life of the loan.

Borrowers pay points to reduce their mortgage interest rate. Each point paid typically reduces the interest rate by 0.25%. So, if you pay one point on a $200,000 loan, your interest rate could be reduced from 4;00% to 3.75%.

Whether or not paying points is a good idea depends on a number of factors, including the length of time you plan to stay in the home, the interest rate environment, and your financial situation. If you plan to stay in the home for a long time and interest rates are low, paying points can save you money on interest over the life of the loan.

Here are some of the pros and cons of paying points⁚

Pros⁚

Lower interest rate
Lower monthly mortgage payments
Can save money on interest over the life of the loan

Cons⁚

Upfront cost
May not be a good option if you plan to move soon
May not be a good option if interest rates are high

If you are considering paying points, it is important to talk to a mortgage lender to see if it is right for you.

Impact on Interest Rate and Loan Amount

Paying points can have a significant impact on your mortgage interest rate and loan amount. Each point paid typically reduces the interest rate by 0.25%. So, if you pay one point on a $200,000 loan, your interest rate could be reduced from 4.00% to 3.75%.

Reducing your interest rate can save you money on your monthly mortgage payments and over the life of the loan. For example, if you have a $200,000 loan with a 30-year term and an interest rate of 4.00%, your monthly payment would be $954.83. If you paid one point to reduce your interest rate to 3.75%, your monthly payment would be $923.30. That’s a savings of $31.53 per month, or $11,355 over the life of the loan.

However, it’s important to remember that points are an upfront cost. Each point paid costs 1% of the loan amount. So, if you have a $200,000 loan, one point would cost $2,000. If you pay two points, the cost would be $4,000.

Here is an example to illustrate the impact of paying points on your mortgage interest rate and loan amount⁚

Loan amount⁚ $200,000

Loan term⁚ 30 years

Interest rate without points⁚ 4.00%

Interest rate with one point⁚ 3.75%

Monthly payment without points⁚ $954.83

Monthly payment with one point⁚ $923.30

Total interest paid over the life of the loan without points⁚ $143,949

Total interest paid over the life of the loan with one point⁚ $132,594

As you can see, paying one point on this loan would save the borrower $11,355 in interest over the life of the loan.

Types of Mortgage Points

There are two main types of mortgage points⁚

Origination points are paid to the lender for processing and underwriting the loan.
Discount points are paid to the lender in exchange for a lower interest rate on the loan.

Origination points are typically charged as a percentage of the loan amount, and they are usually paid at closing. Discount points are also charged as a percentage of the loan amount, but they are paid upfront, before the loan is closed.

The number of points you pay will depend on a number of factors, including the lender you choose, the type of loan you get, and your creditworthiness. Some lenders may offer no-point loans, but these loans typically have higher interest rates. Other lenders may offer loans with a variety of point options, so you can choose the option that best fits your budget and needs.

Here is a table that summarizes the different types of mortgage points⁚

It’s important to note that points are not the only closing costs you will need to pay. Other closing costs may include⁚

Loan origination fee
Appraisal fee
Title search fee
Recording fee
Transfer taxes

When you are shopping for a mortgage, it’s important to compare the total closing costs of different loans, including the cost of points. This will help you determine which loan is the best fit for your budget and needs.

Pros and Cons of Paying Points

There are both pros and cons to paying mortgage points. Here is a summary⁚

Pros⁚

Lower interest rate⁚ Paying points can lower your interest rate, which can save you money on your monthly mortgage payments and over the life of the loan.
Tax deduction⁚ Points are tax-deductible, which can further reduce the cost of paying points.
Faster payoff⁚ Paying points can help you pay off your mortgage faster, as you will be paying more towards the principal balance of the loan each month.

Cons⁚

Upfront cost⁚ Points are an upfront cost, which can be a significant expense, especially if you are paying multiple points.
Not always the best option⁚ Paying points may not be the best option for everyone. If you plan on moving or refinancing in the near future, paying points may not be worth the cost.
May not be available⁚ Some lenders may not offer loans with points, or they may only offer a limited number of points.

Here are some additional things to consider when deciding whether or not to pay points⁚

Your financial situation⁚ If you have the financial resources to pay points, it may be a good option for you. However, if you are on a tight budget, paying points may not be the best choice.
Your loan term⁚ The longer your loan term, the more money you will save by paying points. If you plan on staying in your home for a long time, paying points may be a good investment.
Your interest rate⁚ The higher your interest rate, the more money you will save by paying points. If you have a high interest rate, paying points may be a good way to lower your monthly payments and save money over the life of the loan.

Ultimately, the decision of whether or not to pay points is a personal one. It is important to weigh the pros and cons carefully and make the decision that is best for your individual financial situation.

When to Consider Paying Points

Paying mortgage points can be a good option if you are in a position to do so and if it makes financial sense for your individual situation. Here are some factors to consider when deciding whether or not to pay points⁚

You plan on staying in your home for a long time⁚ If you plan on staying in your home for a long time, paying points can be a good investment. You will have more time to recoup the cost of the points and benefit from the lower interest rate.
You have a high interest rate⁚ If you have a high interest rate, paying points can be a good way to lower your monthly payments and save money over the life of the loan.
You have the financial resources to pay points⁚ Points are an upfront cost, so it is important to make sure that you have the financial resources to pay for them. If you are on a tight budget, paying points may not be the best option for you.
You are not planning on moving or refinancing in the near future⁚ If you are planning on moving or refinancing in the near future, paying points may not be worth the cost. You may not have enough time to recoup the cost of the points before you move or refinance.