When shopping for a mortgage, you'll encounter the option to purchase "points" to lower your interest rate. But what exactly are mortgage points, and when does it make financial sense to buy them? This comprehensive guide will help you understand how points work and determine if they're right for your situation.
What Are Mortgage Points?
Mortgage points, also known as discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate. One point equals 1% of your mortgage amount. For example, on a $400,000 mortgage, one point costs $4,000.
Types of Mortgage Points
Discount Points: These are the most common type, purchased to lower your interest rate. Each point typically reduces your rate by 0.25%, though this varies by lender and market conditions.
Origination Points: These are fees charged by the lender to process your loan. Unlike discount points, origination points don't reduce your interest rate.
How Mortgage Points Work
When you buy discount points, you're essentially prepaying interest to secure a lower rate for the life of your loan. This upfront investment can lead to significant savings over time, but it requires careful calculation to determine if it's worthwhile.
Example Scenario
Let's say you're borrowing $400,000 for 30 years:
- Without points: 7.5% interest rate, monthly payment of $2,797
- With 2 points ($8,000): 7.0% interest rate, monthly payment of $2,661
Monthly savings: $136 Time to break even: $8,000 ÷ $136 = 59 months (about 5 years)
When Buying Points Makes Sense
You Plan to Keep the Home Long-Term
If you intend to stay in your home beyond the break-even point, buying points can generate substantial savings. The longer you keep the mortgage, the more you'll save.