When researching mortgages, you may have come across an unfamiliar term—lumped in with discussions of down payments and interest rates, many lenders will also offer points on the mortgage, or in some cases, require the buyer to pay them upfront. Here are a few of the most commonly asked questions about points—supporting you to make informed decisions.
What are mortgage points?
Essentially, a mortgage “point” is a type of fee that the home buyer pays to the lender when purchasing the home. Generally speaking, a point will be equal to one percent of the total cost of the mortgage. For example, one point on a $250,000 home mortgage will cost the buyer $2,500.
There are actually two different types of points, called discount points and origination points. Since origination points are fees required by the lender, the more important decision for prospective buyers is whether or not to purchase optional discount points at the time you take out your mortgage. However, you may need to consider origination points when calculating how much cash you’ll need on hand to close on your home.
What’s the “point” of points?
Essentially, discount points allow a buyer to reduce his/her interest rate for the lifetime; in exchange for additional upfront cash, the bank lowers the rate. Although offering points is a common practice for most lenders in the U.S., the exact terms may depend on the lender. That being said, it’s typical that a single point will reduce your loan’s interest rate by 0.25%. Depending on the lender, you may have the option of purchasing anywhere from zero to four points on your mortgage.
Using the aforementioned example of a $250,000 home, assuming a 7% rate, an upfront payment of two points—or $5,000—would bring your interest rate down to 6.5%. At a certain point, deciding how many points to purchase becomes a math equation. Even a small difference in interest rates can mean significant savings in the long term, but that all depends on how long you’re planning to stay in your new home.
What else should I consider?
The biggest factor in determining whether or not to purchase points should be the length of time you’re planning to hold onto the house. If you’ll be there for 30 years, it probably makes sense to snap the points up now if you can afford them—you’ll likely save a lot of money in the form of interest over time. But if you’re only going to be there for four or five years, it may be wiser to keep the cash and accept the higher interest rates for the short term.
But you’ll also need to consider how much cash you have available, how big of a down payment you’ll be making, and how much you need to spend on other closing costs, including home inspection fees. It’s also worth mentioning that the money you pay as mortgage points is tax-deductible, though origination points are not.
In the end, choosing whether or not to purchase points is a personal decision, and you’ll want to carefully review your finances and long-term goals before making the call.