Buying a house being one of the most expensive purchases most people will ever make, it is then worth looking at possible ways you can reduce the cost of your mortgage. Apart from shopping for the best mortgage rates and negotiating a good price, some homebuyers might purchase mortgage points, also referred to as “discount points,” to help lower the amount of interest they have to pay on the mortgage.
What are mortgage points and how do they work?
Mortgage points are fees that a home buyer pays the mortgage lender in order to reduce the interest rate on the loan. This is at times known as “buying down the rate”. A single point a borrower buys costs 1% of the mortgage amount. That means, one point on a $300,000 mortgage would cost $3,000.
Every point lowers the rate by 0.25%, therefore one point would reduce a mortgage rate of 4% to 3.75%for the entire life of your loan. However, the amount each point reduces the rate varies from one lender to the other.
Homebuyers are able to buy more than one point or even a fraction of a point. A half-point on a $300,000 home loan for instance would be $1,500. That would lower the mortgage rate by 0.125%.
Origination points
Mortgage origination points being one of the types of mortgage points are fees that are paid to the lender to review, originate and process the loan. Origination points usually cost about 1% of the total mortgage. For instance, if the mortgage lender charges 1.5 origination points for a $250,000 mortgage loan, the borrower then has to pay $4,125.
Mortgage origination points are different from discount points since they don’t directly decrease the interest rate of the loan. Some mortgage lenders will allow homebuyers to get a mortgage with no origination points or reduced closing costs. However, they compensate for that with greater interest rates.
Discount points
Discount points are a kind of prepaid interest. By paying for these points, you decrease the interest rate of your loan by 0.25% per point. You can as well purchase a fraction of a point up to three points or more.
It is possible to decrease your monthly payments by reducing your loan interest rate. However, this needs an upfront payment. You can get more benefits from paying for the points if you plan on living longer in the home.
Mortgage discount points vs. APR
Purchasing discount points on your mortgage loan is a way of prepaying some of the interest. Taking a look at the annual percentage rate (APR) will enable you to compare the loans with different point combinations and rates. The APR includes the interest rate and the points you will pay and any additional fees the lender charges you.
What is the breakeven point?
The way to calculate the breakeven point at which the homebuyer will recover what was paid on prepaid interest, you need to divide the fee of the mortgage points by the amount saved each month by the reduced rate:
$4000/$56 = 71 months
This simply means that the homebuyer will have to be in the home for 71 months, or close to 6 years, to recover the price of the discount points.
Are mortgage points the right choice for you?
Purchasing mortgage points is one way to pay upfront and lower the total cost of the mortgage loan as well as decrease your monthly payments. This makes more sense for someone who has plans to live in the home for a longer period of time. The upfront cost is worth it when you think of the amount you will save every month.
On the other hand, if you don’t plan on staying in the house for a long time, paying for points would make you lose money.
Another concern is whether it would be more beneficial to pay for points or put down a larger down payment. In this case, a larger down payment can help you get a lower interest rate. However, if you are able to hit the 20% down payment mark, you can also avoid additional cost on PMI.
The bigger your down payment is, the better interest rate you get since it decreases your loan-to-value rate (LTV), which refers to the size of your mortgage in comparison with the value of your home.
To learn more about what mortgage points are, how they work and other mortgage services, Pillar Mortgage is here for you. We are ready to help you through every step of the entire mortgage process from start to finish. Call us today!
