Mortgage Points: What They Are & How They Work

Mortgage Points: What They Are & How They Work

For a lot of people, it’s hard to be excited about owning a home because of the cost of mortgages, closing costs, and other fees that you’ll now be responsible for. However, there are some ways to alleviate the burden.

Mortgage points, also known as discount points, are one example of how you can save on your mortgage payments and start to enjoy the more important aspects of owning a brand new home.

Let’s take a look at everything you need to know, including how they work and if they’re the right move for you

What is “A Point” and How Does It Work?

While it might sound like a mortgage point is something you’d win in a game, no one here is keeping score. Instead, mortgage points are fees that you can pay directly to a lender in exchange for a reduced interest rate. Sometimes, you may hear someone refer to this as “buying down the rate.”

Essentially, you’ll be paying a portion of the interest upfront to make lower interest payments throughout the loan. Typically, one mortgage point equals 1% of the total mortgage amount. You can buy multiple points or even fractions of points.

How Do Mortgage Points Work?

The concept of paying more money upfront might seem counterintuitive, but let’s look at an example to understand better how these might be beneficial.

Let’s say you’re taking out a $100,000 mortgage. For a 30-year loan at 3.5% APR, you’d be making monthly payments of $449 every month. But let’s say you have some disposable income upfront, and you’re able to buy some mortgage points.

At 1% of the mortgage price, you can purchase a single point upfront for $1,000. If you were to buy four points for $4,000, you’re now only paying off $96,000 throughout the loan, leading to lower interest rates from the start. That means you’re only paying $431 each month.

Of course, it will take several months before you “break-even” and the interest you’ve saved compensates for the initial cash investment. By dividing your upfront mortgage point costs by your monthly payment savings, you can figure this out.

So in the example above, you’d take $4,000 divided by $18, which means it would take 222 months (18.5 years) before you break even.

As you can see, that’s a long period, so the upfront costs might not be worth it for every single situation. Let’s look at when it might make sense to purchase mortgage points.

Who Should Consider Paying a Point or Two?

There are a few circumstances when it makes the most sense to buy mortgage points rather than just making payments as normal.

If You Have a Fixed Rate Mortgage

While you can buy mortgage points for any type of mortgage, including jumbo loans, it’s usually recommended that you only purchase them for fixed-rate loans.

If You’re Planning on Living in Your Home for a Long Time

Since it can take many years before you start to see the benefits of buying mortgage points, it is usually only recommended if you’re planning to live in your home for a long time. If you move out of your home or even refinance, you’ll lose all of the potential savings from your upfront payment before you break even.

Mortgage Points vs. Down Payments

Mortgage points are an upfront cost that you’ll pay before you close. However, this differs from making a down payment.

Down payments are a necessary payment that you’ll need to make before closing to give the lender a “safety net” if you default on the loan. While FHA loans allow you to make a down payment of as little as 3.5% upfront, it’s recommended that you make a 20% down payment of the total mortgage cost to avoid paying private mortgage insurance or PMI.

Private mortgage insurance is a monthly fee that usually amounts to .58% to 1.86% of your original loan amount. It can be pricey and frustrating. With that in mind, you typically want to choose a higher down payment instead of paying for mortgage points if it comes down to it.

This is because the savings of not having to pay PMI is likely to be higher than what you’d save from mortgage points.

Mortgage Point FAQs

Network Capital does not charge any application, lender or origination fees unlike so many other lenders in the market today. So beware of this when you are speaking to lenders, what are the fees that they charge and are they necessary?

Are Mortgage Points Tax Deductible?

Another benefit of discount points is that they are tax deductible as home mortgage interest. If you’re able to deduct all of the interest on your mortgage, you may be able to deduct all of the points that you’ve paid on the mortgage as well. With that said, you need to meet several criteria in order to take a deduction for all of the points that you paid within that tax year.

You must list the deduction on Schedule A of Form 1040, and you’re able to deduct up to $750,000 worth of your mortgage debt. Origination points are not tax deductible. But always check with your financial advisor or accountant for your specific situation.

Can You Negotiate Mortgage Points?

The homebuying process may take some negotiation just like buying your forever home, and you may be able to negotiate lower interest rates or lower closing costs. You may also be able to do the same with mortgage points.

Run the numbers to see if it would be worth it to buy mortgage points in the first place. But you may be able to see if a lender is willing to give you more points for less money. You can sometimes negotiate origination fees as well.

If you’re able to put 20% down and you have a strong credit score, you’re usually in a better place in terms of bargaining power.

Other Ways to Save on a Home Mortgage

Buying down the rate with points may not be the best move for your specific situation, but that doesn’t mean there’s nothing you can do to bring down your rates. Always, check with your accountant or financial advisor for each situation and make sure they understand what you’re thinking and what your plan is.

Extend Your Loan Term

Many people like to choose 15-year mortgages because the thought of being out of debt sooner is more appealing. While it’s a great feeling to be debt free, monthly payments will be higher the shorter the loan term is.

With that in mind, thoughtfully take a look at your budget and consider extending the length of your term to diminish those monthly payments. For instance, your monthly payments on a $100,000 mortgage at 3.5% APR is $449 for a 30 year mortgage, but it’s $715 for a 15 year mortgage.

With that said, since you’re paying off your principal balance sooner with a shorter term, you’ll save more money overall. But it sometimes makes more sense to alleviate the initial financial burden by extending the length and making smaller payments. You can always refinance down the line to a shorter loan term to pay off your debt quicker.

Shop Around

One of the most important practices to adopt when shopping for a loan is to take your time and do some research. Every lender will offer different interest rates, packages, terms, and discounts that might appeal to you specifically.

If saving money and time are two priorities for you, then Network Capital might be the right choice. Our streamlined mortgage process happens all under one roof, from underwriting to closing. There are less communication hiccups, meaning we can get you to the closing table in as little as 15 business days.

With competitive rates and $0 lender fees on certain programs, we’re committed to helping you live your best life. To learn more about our mortgage programs, click here.

Strengthen Your Credit

When a lender is reviewing your loan application, they don’t know anything about you except for what they can see on paper. And they want to make sure that they’re giving out a loan to someone who seems like they’re financially able to pay off the loan without defaulting.

For that reason, having a strong credit score off the bat can greatly enhance your chances of getting better loan terms and lower interest. This is because the lender is more certain that you’ll pay off the entire balance throughout the loan, so there’s no need to hike up the interest.

If you have lower credit, there are still plenty of options, such as FHA loans that are perfectly reasonable. However, these tend to have higher interest rates because you are more of a risk to the lender, and therefore they need to have a safety net in case you can’t make any more payments.

In Conclusion

Mortgage discount points are fees that you can pay upfront in exchange for a lower interest on the life of your loan. Typically, one point equals 1% of your total loan amount.

While making a large lump payment upfront might seem strange, it can lower your monthly interest payments and allow you to save money once you reach the break-even point. In most cases, you’ll hit that point after several years.

Because of that, it makes the most sense to get mortgage points if you know you’ll live in your home for a long time and you have no thoughts of refinancing.

Additionally, since they only apply to the fixed-rate portion of an ARM loan, they are only recommended for fixed-rate loans.

Getting home loans can be confusing, but at Network Capital, we make it as easy as can be. We’ll work directly with you to provide you with fast closing, competitive rates, and flexible loan terms that match your specific situation and close your loan in as few as 15 days.

Sources:
WARM & Interest Only ARM vs. Fixed Rate Mortgage | Military Officers Association of America
Loans | US Department of Housing and Urban Development (HUD)
What is private mortgage insurance? | Consumer Financial Protection Bureau