How Much Do Points Cost On Mortgage

Mortgage points, often referred to as discount points, typically cost around 1% of your loan amount. For instance, if you’re taking out a $300,000 mortgage, one point would cost you $3,000. Generally, paying points can lower your interest rate by about 0.25% to 0.5%, depending on the lender and market conditions. So, while you pay upfront for these points, they can save you money over the life of your loan.

What Are Mortgage Points?

Mortgage points are fees paid directly to the lender at closing in exchange for a reduced interest rate on your mortgage. There are two types of points: discount points and origination points.

Discount Points

Discount points lower your interest rate. Essentially, you’re paying some interest upfront. It’s worth noting that one point equals 1% of your loan amount. So, if you have a $250,000 mortgage, one discount point would cost you $2,500. The reduction in your interest rate can save you money over the life of the loan, making it a popular option for many borrowers.

Origination Points

Origination points are fees charged by the lender to cover the costs of processing your loan. These don’t affect your interest rate like discount points do. If you see origination points on your loan estimate, it’s best to clarify with your lender what those fees cover.

How Do Points Affect Your Mortgage Payments?

Let’s break down how paying points can impact your monthly payments and overall loan costs.

Example Scenario: Sarah’s Decision

Sarah, a 35-year-old teacher in Denver, is looking to buy her first home. She finds a $300,000 mortgage with a 4.5% interest rate. Her lender offers her the option to pay 1 point to lower her rate to 4.25%. Here’s how it breaks down:

Without Points:
- Loan Amount: $300,000
- Interest Rate: 4.5%
- Monthly Payment: ~$1,520 (principal and interest only)
- Total Interest Paid Over 30 Years: ~$227,000
With 1 Point:
- Cost of Point: $3,000
- New Interest Rate: 4.25%
- Monthly Payment: ~$1,475
- Total Interest Paid Over 30 Years: ~$215,000

In this scenario, paying $3,000 to reduce her rate saves Sarah around $45 on her monthly payment and nearly $12,000 over the life of her loan.

When Should You Consider Paying Points?

Deciding whether to pay points boils down to how long you plan to stay in your home. If you’re planning to move within a few years, paying points might not be the best option. But if you foresee staying in your home long-term, it could save you a significant amount in interest.

Break-Even Point

To figure out if paying points makes sense, calculate your break-even point. This is when your savings from a lower monthly payment equal the upfront cost of the points.

Using Sarah’s example, she saves $45 per month with the point:

Cost of Point: $3,000
Monthly Savings: $45
Break-Even Point: $3,000 / $45 = 67 months (or about 5.6 years)

If Sarah plans to stay in her home for more than 5.6 years, paying for the point could be worth it.

Different Types of Loans and Points

Points can vary based on the type of mortgage you’re applying for. Let’s explore a few common loan types.

Conventional Loans

With conventional loans, points are often used to reduce the interest rate. They can be beneficial for buyers with strong credit scores looking to lower their monthly payments.

FHA Loans

FHA loans may also have points, typically in the form of upfront mortgage insurance premiums. It’s crucial to weigh these costs against the benefits of a lower down payment requirement.

VA Loans

VA loans don’t require mortgage insurance, but you may still see points offered to lower your interest rate. Given the benefits of VA loans, many veterans find paying points makes financial sense.

How to Calculate Points in Your Mortgage

Calculating points is straightforward, but you need to factor in your specific loan amount and the interest rate reduction offered.

Step-by-Step Calculation

Determine Your Loan Amount: Let’s say you have a $400,000 mortgage.
Find the Cost of Points: If the lender charges 1 point, that’s $4,000 (1% of $400,000).
Estimate Interest Rate Reduction: If paying the point lowers your rate from 4.5% to 4.25%, calculate the new monthly payment.
Compare Payments: Look at the difference in monthly payments and total interest over the life of the loan.

Example: Tom’s Decision

Tom, a 40-year-old engineer in Chicago, is considering a $400,000 mortgage. The lender offers him the option to pay 2 points to reduce his interest rate from 4.5% to 4%. Here’s how it plays out:

Without Points:
- Monthly Payment: ~$2,027
- Total Interest Paid Over 30 Years: ~$186,000
With 2 Points:
- Cost of Points: $8,000
- Monthly Payment: ~$1,909
- Total Interest Paid Over 30 Years: ~$146,000

Tom saves about $118 per month. To find his break-even point:

Break-Even Point: $8,000 / $118 = 68 months (or about 5.7 years)

If Tom plans to stay in his home for more than 5.7 years, paying the points makes sense.

Pros and Cons of Paying Points

Before you decide to pay points, consider the pros and cons.

Pros

Lower Monthly Payments: Paying points reduces your monthly mortgage payment.
Long-Term Savings: Over the life of the loan, you could save thousands in interest.
Tax Deduction: In some cases, points may be tax-deductible.

Cons

Upfront Cost: Paying for points means higher closing costs.
Not Always Worth It: If you sell or refinance before your break-even point, you might lose money.
Market Variability: Interest rates change, which can impact the value of paying points.

Frequently Asked Questions

1. Are mortgage points the same as closing costs?

Not exactly. Points are part of your closing costs, but not all closing costs are points. Closing costs include a variety of fees, such as appraisal fees, title insurance, and more.

2. Can I negotiate points with my lender?

Yes, you can negotiate points. Lenders may offer different options, so it’s worth discussing your preferences and seeing if they can adjust the points or other fees.

3. How do I know if paying points is worth it?

Calculate your break-even point, as discussed earlier. If you plan to stay in your home beyond that timeframe, paying points may be worthwhile.

4. Can I finance the points into my mortgage?

Some lenders allow you to roll the cost of points into your mortgage. This means you won’t have to pay them upfront, but it will increase your loan amount and monthly payments.

5. What happens if I pay points but refinance later?

If you refinance, you won’t recoup the upfront cost of the points you paid on your original mortgage. It’s essential to consider how long you plan to stay in your home before deciding to pay points.

Conclusion

In the end, whether or not to pay points on your mortgage boils down to your individual financial situation and plans. Carefully consider how long you’ll stay in your home, calculate your break-even point, and don’t shy away from talking to your lender about your options. By crunching the numbers and understanding the implications, you can make a decision that aligns with your financial goals. If you’re still unsure, consider speaking with a mortgage advisor to find the best path forward for you.