| The Effect of Paying Points on a $200,000, 30-Year Mortgage | |||
|---|---|---|---|
| No points | 1 point ($2,000) | 2 points ($4,000) | |
| Annual Percentage Rate (APR) | 4.5% | 4.25% | 4.0% |
| Monthly Payment | $1,013.37 | $983.88 | $954.83 |
| Monthly Payment Savings | -- | $29.49 | $58.54 |
| Breakeven Time to Recover Point Cost | -- | 68 months | 68 months |
| Total Savings Over Loan Lifetime | -- | $10,616.40 | $21,074.40 |
The longer the life span of a loan, the more you pay interest on it—that’s how financing works in general. So points are ideally suited for a fixed-rate, long-term mortgage (20 to 30 years) that most likely isn’t going to be refinanced anytime soon.
How to Pay for Mortgage Points
A borrower who pays discount points is likely to have to meet these costs out of pocket. However, many scenarios exist, particularly in buyer’s real estate markets, in which a seller offers to pay up to a certain dollar amount of the closing costs. If other closing costs, such as the loan origination fee and the title insurance charge, do not meet this threshold, then the buyer can often add discount points and effectively lower their interest rate.
Reducing your mortgage interest rate with discount points does not always require paying out of pocket—particularly in a refinancesituation, in which the lender can roll discount points, as well as other closing costs, into the new loan balance. This prevents you from paying more money at the closing table, but it also reduces your equity position in the home.
Because the Internal Revenue Service (IRS) considers discount points to be prepaid mortgage interest, theygenerally are tax deductible over the life of the loan. If they and the home purchase meet certain conditions, then they can be fully deductible for the year when they were paid.
Can You Negotiate Mortgage Points?
Points are definitely open to negotiation. The number of points you buy—or whether you buy any at all—is up to you. Typically, when lenders are displaying the mortgage options for which you qualify, they’ll show you several different rates, including the ones that you can get if you purchase discount points.
Strictly speaking, you’re not negotiating the points themselves but a lower interest rate for the life span of the loan. The terms of the points—the cost of each point, and how much it lowers the annual percentage rate (APR)—are set by the financial institution. But if you’ve shopped around and can show them a better deal elsewhere, then they might match it—especially if you have a strong credit history and seem like a responsible, desirable client.
Discount points and origination points are not the same. Origination points are fees that lenders charge for finalizing a mortgage—part of the closing costs on a home purchase. Origination points essentially are a surcharge that doesn’t relate to the interest rate and they generally aren’t optional, negotiable, or tax deductible.
Should You Buy Discount Points?
For lenders, discount points have a distinct advantage: They receive cash up front, instead of having to wait for money in the form of interest payments over time. This can enhance the financial institution’s liquidity.
Borrowers also gain benefits from discount points—the main one being lower payments over the life of your loan. Basically, you are paying some interest in advance—at the onset of your mortgage—in exchange for a decreased interest rate later. However, this benefit applies only if you plan to hold onto the mortgage long enough to save money from the smaller interest payments.
For example, a borrower who pays $4,000 in discount points to save $80 per month in interest charges needs to keep the loan for 50 months, or four years and two months, to break even. If the borrower thinks they might sell the property or refinance their loan before 50 months have passed, then they should consider reducing what they pay in discount points and taking a slightly higher interest rate.
In general, the longer that you plan to own the home, the more that points help you save on interest over the life of the loan. At the end of the day, though, the benefits of discount points depend on the math. If you can afford to shell out a few thousand more up front, then they can result in significant cost savings over the long term, particularly if the home requires renovations. Or they can be an unnecessary cost that the borrower could have avoided with some more structured planning.
How Much Does 1 Point Reduce a Mortgage Rate By?
When you buy 1 point to reduce your mortgage interest, you can typically reduce it by 0.25%, although the exact amount will vary by lender. So, if your interest rate was 6.5% and you bought two points, your new interest rate could be 6%. A mortgage point typically costs 1% of your mortgage.
What Are Lender Credits?
Lender credits, opposite of mortgage discount points, are when you receive a higher interest rate and, in return, the lender provides you funds to offset your closing costs. When you use lender credits, you will pay more in the long-term in interest.
How Many Mortgage Points Can You Buy?
Lender can set their own terms for the amount they charge for points and fees. For lenders making qualified mortgages under the ability-to-repay rule, The Consumer Financial Protection Bureau then limits the amount of points and fees they can charge. For loans of $100,000 or more, lenders may only charge up to 3% of the loan for qualified mortgages.
The Bottom Line
If you can afford to buy mortgage points along with your mortgage, you can save a significant amount in interest over the long-term. However, if you only plan to hold your property for a short period or if you are tight on cash, mortgage points may not make sense. Weigh the pros and cons, perhaps with the help of a financial advisor, to determine whether buying mortgage discount points is a good idea for you.
