Buying a house is a significant investment. In addition to the home’s cost, you must pay closing costs that can be 2% - 5% of the loan amount.
While most closing costs are non-negotiable, mortgage points aren’t something you must pay. Instead, you can shop around to find a lender that won’t charge them or try to find a lender with more competitive rates without paying points.
Keep reading to learn the answer to how mortgage points work to help you determine if you should pay them.
What are Mortgage Points?
Mortgage points are prepaid interest a borrower pays a lender at the closing. Points are displayed as a percentage of the loan amount and help lenders cover the cost of processing a loan.
You might also pay mortgage points if you want a lower interest rate. Some lenders allow you to buy down the rate by paying the points upfront.
Either way, mortgage points are a part of the closing costs and increase the cash needed to close. If you compare your options from multiple lenders, compare apples to apples and determine what closing costs they charge, including whether they charge mortgage points. Some lenders wrap all closing costs into mortgage points, and others itemize the costs and don’t charge points.
Types of Mortgage Points
There are two types of mortgage points to consider – origination and discount points. Origination points aren’t optional, but discount points are optional and can be negotiated.
Lenders require origination points for specific loan files. For example, lenders may charge you origination points to close the loan if you have a complicated loan file or risky qualifying factors.
Origination points don’t affect your interest rate but increase the cash needed to close. For example, if you borrow $200,000 and the lender charges you two points, you’d need $4,000 for the origination points plus the amount of the other closing costs.
Some lenders wrap all the closing costs into points, rather than itemizing the costs. Always ask the reason for the points and what’s included in the cost.
Discount points are optional points borrowers can choose to pay to buy down the interest rate. One point typically decreases a rate of 0.25%, but it varies by lender. So always ask how much one point would buy the rate down if discount points interest you.
Buying discount points lowers your monthly payment but increases the overall cost of the loan, so always make sure it makes sense to buy the rate down.
Depending on the lender, you may be able to negotiate the discount points or get a higher discount on the rate for the points you pay.
How do they Work?
Lenders quote origination or discount points when you apply for the loan. They’ll include them on the Loan Estimate that you receive three business days after applying for a loan.
You can see how the origination or discount points affect your loan payment and the total cash needed to close. If you can’t afford the points, you can talk to your lender about other options. Sometimes they can work the numbers to avoid the origination points and still get you the loan.
If you choose to pay the points, the lender will include them in the closing costs, which means you’ll need more cash to close the loan. However, if you refinance the loan or sell the home in the future, you don’t get the points back.
Who Should Pay Mortgage Points?
Since mortgage points increase your cash to close, who should pay them?
It depends on the situation.
- If you don’t qualify for a mortgage without paying points, you must decide if the payment is affordable and if you can pay the points.
- If you want a lower interest rate, you may choose to buy the rate down and pay the extra money upfront.
- On the other hand, you might be able to negotiate with a lender to get a better deal by wrapping all your costs into origination points.
Understanding the Break-Even Point
If you choose to buy the rate down with discount points, it’s important to determine your break-even point.
This is the point that you’d pay back the origination points and enjoy the savings with the lower rate. It doesn’t always make sense to buy the rate down.
To figure it out, compare the savings between paying discount points and not paying them. Say, for example, you’ll borrow $200,000 at 7%, but if you pay 1.5 points, you can get the rate down to 6.5%.
The payment on the 7% rate on a 30-year fixed rate would be $1,330.60. The payment at 6.5% would be $1,264.14. That’s a savings of $66.46.
The 1.5 points would cost you $3,000, so it would take 45 months to break even. However, you might consider paying the points if this is your forever home. After almost four years, you’d save $66.46 a month or $797.52 and $20,735.52 over the remainder of the term if you kept the home for the full 30 years.
It likely wouldn't make sense if you plan to move in five years, for example. You’d give up capital to save $66.46 a month, only to move a year after you broke even.
Also, consider if you’ll refinance within that time. While no one can predict the future, consider if you’d tap into your equity or try to refinance for a lower rate if rates dropped in the next couple of years.
Mortgage points sound like another expense that homebuyers don’t want to pay, but they have many benefits.
Whether you need to pay the points to get approved for the loan or you want to pay them to get a lower interest rate, they can save you money and help you buy a home. At Loan Factory, we help you find the lender with the most competitive rates and terms, including mortgage points, to ensure you get the loan that makes the most financial sense.
If you’re ready to explore your options for a mortgage loan, contact us today to see how we can help!
-> Learn more: How to Choose a Mortgage Lender