Are Mortgage Points Right For You?

There are many factors that affect your interest rate. To name a few: your down payment size, your median FICO® Score, the term of your loan and how you plan to occupy the property. However, what does not immediately come to mind for most people is the ability to pay for a lower interest rate.

In this article, we’ll discuss mortgage points – also known as discount points or just points – and how to make comparisons when buy a mortgage. By the time you finish reading, you should have the tools you need to know if buying points are right for you.

What are mortgage points?

Mortgage points are prepaid interest. You pay points at close in exchange for a lower interest rate than you would otherwise get if you didn’t pay the interest up front. One point is equal to 1% of the loan amount. If you were to pay for three points on a $ 100,000 mortgage, it would be $ 3,000, but three points on a $ 300,000 mortgage is $ 9,000, so the cost can add up quickly.

You need to do some math to determine if you think the points will be worth it for you. However, it’s not too complicated, and we’ll break everything down in a minute.

When considering purchasing points at a lower interest rate, it’s also important to note that you don’t have to pay for a full point to get a lower rate. Points are sold in increments of up to 0.125%.

The mechanics of mortgage points

When considering mortgage points, you should know that you can pay them to lower your interest rate, but your lender may also give you lender credits. This is when they take money from your closing costs in exchange for a higher rate over the life of the loan. The increments for lender credits also start at 0.125% of your loan amount. If you are looking to save on closing costs, this is what a lender is referring to when they talk about a rate that “pays off the points”.

If you choose to pay points to lower your interest rate, it’s important to calculate the breakeven point. Fortunately, this doesn’t require any crazy math. The formula is as follows:

Amount paid for points
_________________________________________________
Monthly payment without purchasing points – monthly payment with points

The result of this equation will give you the time (in months) it would take to break even on your investment and start saving money for the rest of the life of your loan. If you do the math and expect to stay in the house longer than that period of time, it might be a good idea to buy the points. If you plan to move before the breakeven point, you shouldn’t buy the points, or you should consider buying a lower amount.

Example of mortgage points

The easiest way to get a feel for this is to look at a quick example to understand how stitches work in practice. You can also play around with your own interest rates and loan terms using our amortization calculator.

For the purposes of our example, let’s say you are considering a 30-year fixed loan of $ 300,000. The monthly payments below only take into account principal and interest. Taxes and insurance vary. While we’ve tried to make this example as realistic as possible, different lenders will give different interest rates for the same number of points, so it’s worth shopping around.

Points Cost at closing Interest rate Monthly payment Savings on monthly payments Equilibrium period 30-year loan payment savings
0 $ 0 4.99% $ 1,608.63 N / A N / A N / A
1.25 $ 3,750 4.75% $ 1,564.94 $ 43.69 7 years, 2 months $ 15,728.40
1.75 $ 5,250 4.5% $ 1,520.06 $ 88.57 5 years $ 31,885.20
2 $ 6,000 4.25% $ 1,475.82 $ 132.81 3 years, 10 months $ 47,811.60

How many mortgage points can you buy?

Mortgage lenders do not set specific limits on the number of Mortgage Points you can purchase. That said, there are federal and state guidelines regarding the amount you can be charged to close a mortgage.

While nothing is difficult and quick because state rules vary, regulations generally make it difficult to purchase more than about four points.

Should you buy mortgage points or make a larger down payment?

Every situation is different, so we won’t get specific advice on whether it’s more worth buying Mortgage Points or making a slightly larger down payment. Since both have the potential to lower your rate, however, we can go over some factors you should think about.

If you get a conventional loan and are about to have a 20% down payment or equity amount in a refinance, it might make more sense to put the money you have available towards the down payment. funds rather than buying mortgage points. The reasoning behind this is that you are not paying for private mortgage insurance (PMI) which can save you monthly fees in the case of borrower paid mortgage insurance (BPMI) and prevent you from paying a higher rate. high with a mortgage loan paid off. insurance (LPMI).

If you are not near the 20% threshold, you should work closely with your mortgage lender to determine your options. Interest rates are grouped together based on your median FICO®score and occupancy – whether the property will be your primary residence or a vacation or rental home, as well as the size of your down payment. A mortgage expert will be able to run the numbers to see if you’re saving more money by paying a certain number of points or by making a slightly larger down payment.

Understanding the impact of mortgage points on variable rate mortgages (ARMs)

With a ARM, you get a lower initial fixed rate than what you would get for a fixed rate loan with a comparable term at the start of the loan. This usually lasts 5, 7 or 10 years depending on the loan option you choose. The reason mortgage investors are willing to give you that initial rate at some point is that the rate can then adjust up or down to match current market conditions, subject to certain movement caps. on the rise.

The investor has the advantage of not being asked to project inflation not so far in advance because the rate may change at the end of the set period. However, it is important for anyone who obtains an ARM to note that the points they purchase only apply to the initial interest rate, and not to subsequent adjustments. So some of your point calculations may change if you have fewer years to break even and save money on that payment.

Compare mortgage rates

When lenders set mortgage rates, you don’t always see the zero rate for advertising purposes. The rates shown often assume that you will pay for a certain number of points. Lenders are required to disclose any assumptions they make when setting the rates they advertise. Points will be one of those disclosures, with your median FICO® Note and loan-to-value ratio (LTV)– the reverse of your down payment or your equity. For example, if you put down a 3% deposit, you have an LTV ratio of 97%.

A very easy way to get an idea of ​​the overall cost of the loan is to look at the Annual Percentage Rate (APR). For any loan you get, there will be two interest rates shown. One is the base interest rate you get based on factors like credit, LTV, and occupancy. Beside that there will be a higher rate. This is the APR and it takes into account closing costs to calculate the total cost of the loan. The larger the difference between the interest rate and the APR, the higher the closing costs you can expect to pay.

Discount points are just one of the many factors that affect the cost of closing, but it gives you an idea of ​​what to look for when shopping. Pay attention to the assumptions associated with any advertised rate.

Now that you have mastered the mortgage points, you should feel a lot more confident in your quest for real estate financing. Whether you are looking to buy or refinance, you can get started online with Rocket mortgage® by Quicken Loans® or call one of our mortgage experts at (800) 785-4788. If you have any questions for us, you can leave them in the comments below!

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