Mortgage points offer a means of reducing your mortgage interest rate by purchasing points upfront. Each point helps your mortgage interest rate and one point is charged at 1% of the amount of your mortgage loan. Thus, if your mortgage loan is $150,000, each point will cost you $1,500.
Generally, mortgage lenders will offer you anything from zero to 3 points. If you want to buy points, make sure you ask whether or not this is possible right from the start. Make sure that you discuss ‘discount points’ because there are two types of points on a mortgage.
These are mortgage points that are paid to loan officers to compensate them for their evaluation, processing and approval of the mortgage loan. Not all lenders charge them, and you can often negotiate how many should be paid. It is common for bad credit loans to be charged more points than regular mortgages. These are also charged at 1% per point.
These are the points on a mortgage that we are discussing here – a form of prepaid interest. Unlike origination points, discount points are tax deductible. You should ask your potential lender how many discount points you can purchase on a particular mortgage.
Points on a Mortgage: Doing the Math
You can use any online amortization calculator to work out how much you will save on your monthly repayments for each point you buy. You can then figure out how many years it would take to breakeven and recover your mortgage points payment.
Here is an example:
Let’s say you borrow $150,000 at an interest rate of 4.0% over a period of 30 years. When you enter these figures into an amortization calculator, you will find that your monthly repayment will be $716.12.
Let’s compare purchasing 1 point at $1,500 with 3 points at $4,500 (each point is 1% of the mortgage loan.)
1 Point: Interest rate = 3.75% Monthly payment = $694.67 Saving = $21.45/month
3 Points: Interest rate = 3.25% Monthly payment = $652.81 Saving = $63.31/month
If you divide each of these savings into the amount they cost, you will find that purchasing 1 point will take 69.93 months to repay = 5 years+10 months. Purchasing 3 points will take 71.07 months to repay, or 5 years+ 11 months.
Each takes fundamentally the same time to break even. After these periods of time, you will then be better off each month than if you had purchased no mortgage points. In fact, by buying just one point you would save a total of 360-70 months = 290 x $21.45 = $6,2220.50 better off over the 30 year term, rising to 289 x $63.31= $18,296.59 for 3 points.
Are Mortgage Points Worth the Cost?
The math says yes, as long as you are in the home past the break even point! However, you will already have cash to pay out in closing costs and any origination points charged. This might strain your cash reserves, particularly if this is your first home and you have furniture and so on to purchase.
Nevertheless, if you can afford them, mortgage points are worth paying for. They reduce your monthly repayments to a more affordable level, and you certainly gain more than if you had paid the points money as a higher down payment.
Let’s do the math on that. Let’s say that, rather than purchase 3 points, you had paid the $4,500 as a down payment.
Your monthly repayment would be based on a loan of $145,500. At 4% interest over 30 years that would amortize to $694.64 – compared to $652.81 by spending the $4,500 on 3 points. So mortgage points win every time over an extra down payment.
Some people claim that you would be better investing your payment in stocks. Over the 30 years that would increase by more than you gain with mortgage points. That may or may not be the case. However, most people would rather pay a smaller monthly mortgage repayment, and be more certain of affording their mortgage.