- 28 Dec, 2023
What are mortgage points and how do they work?
Does buying three points on a mortgage lower your rates?
Are you on the journey to buy a house with a mortage? If yes, then understanding the nitty-gritty details of mortgage points is crucial.
With housing prices on the rise, anything that has the potential to reduce the cost of a mortgage is worth checking out.
In this blog, let’s explore how mortgage points work, understand the types of points on a mortgage, and identify when it's wise to utilize them.
What are mortgage points?
Mortgage points also called discount points are used to lower your interest rates and they work more like a fee. They are a form of prepaid interest.
The idea here is to reduce your monthly mortgage payments and lower your interest rate over the life of the loan in exchange for an upfront payment.
Let’s help you understand it better! When you take out a mortgage for $100,000, one point would cost you 1% of the mortgage amount which is equal to $1,000.
The total number of points on a mortgage that you are willing to pay depends on your affordability. The longer you plan to live in your home, the more you will benefit from paying these points.
As with any other form of debt, interest rates add up to your monthly mortgage payments and if you want to take out a large loan, making those hefty payments every month can be quite a strain.
The number of mortgage points you pay is based on how much money you're borrowing. In simple terms, if you're taking out a bigger home loan, you'll likely pay more points than a smaller loan.
Alright, you have done a great job grasping the concept of mortgage points! Get ready to explore the different types of buying points on a mortgage. Let's go.
Break down of discount vs. origination points
You have mastered the basics of mortgage points. It is now time to learn about the two types: Mortgage discount points and origination points.
Discount points
They are your ticket to negotiating a lower interest rate on your mortgage. As discussed above, each point typically costs 1% of your loan amount, paid upfront at closing. It acts like a trade-off, an initial payment for a more affordable interest rate over the life of your loan.
If you’re willing to pay more upfront to secure a better deal on your interest rate, you can go ahead and buy your points.
The more points you buy, the more you can potentially lower your interest rate, leading to long-term savings.
While there's an upfront cost associated with paying mortgage discount points if you have the affordability you can maximize your savings.
Calculate the break-even point to understand when your upfront investment will start paying off through reduced monthly payments
If you’re looking for substantial long-term savings, especially if you’re planning to stay in your home for an extended period, this could be the best option.
However, you need to be mindful because paying the discount points for a mortgage requires a significant upfront payment, making it essential to assess your financial situation and homeownership goals.
So, the main goal of the discount point is to help you manage your monthly mortgage payments.
Now, what is an origination point? Are they any different? Keep reading to know the answer.
Origination points
Origination points, also known as loan origination fees, are charged by your lender to create, review, and process your loan.
They also work like your mortgage discount points, where 1 origination point equals 1% of the total mortgage.
The origination points can be used against the mortgage as well for the closing costs. The cost of your total points can be used as a tax-deductible if they are being used for a mortgage rather than closing costs.
Unlike discount points, origination points don't directly impact your interest rate. Instead, they contribute to the overall expenses associated with securing the loan.
While they can lead to a faster loan approval process, it's essential to weigh the costs and your ability to afford these costs
The origination points on a mortgage vary from one lender to another and we recommend you to shop around and negotiate with your lenders.
The main difference between the two is that mortgage discount points are used to lower the monthly payments of your mortgage whereas origination points on a mortgage are used to cover any overhead costs associated with your loan.
Now that you have a clear understanding of how each type of mortgage point works, it is time for us to focus on the benefits of mortgage points.
Top 3 benefits of using mortgage points
Borrowers usually use their opportunity to purchase mortgage points to reduce their interest rates. But, there is more to paying points on a mortgage than just lowering the rates. Let’s see what they’re all about!
Save thousands of dollars
While acquiring mortgage points can result in higher upfront closing costs, the substantial reduction in interest rates may make your initial investment worthwhile.
If you plan to live in your home for a long period of time, paying the upfront costs can help you save thousands of dollars in terms of monthly mortgage payments, potentially helping you save up to tens of thousands of dollars.
Reduces your monthly payments
Investing in mortgage points lets you secure a lower interest rate, leading to a substantial decrease in your monthly mortgage payment.
The reduction means a smaller portion of your monthly payment goes toward interest, allowing you to allocate more funds toward the principal balance. This enables you to become a homeowner sooner.
Helps you save on tax payments
Mortgage interest is usually tax-deductible, and the cost of discount points is considered prepaid mortgage interest.
Paying these points helps you to reduce your tax payments. To have a better understanding of how your tax is calculated and reduced from paying these mortgage points, it is better for you to consult with a tax expert.
These benefits vary depending on the type of lender you choose and the amount you’re willing to pay as your mortgage points.
Therefore, there are certain situations where you can use the opportunity of these mortgage points to your advantage and certain situations where you can stay away from these mortgage points.
Let’s see the right time to purchase points on a mortgage below.
When is the right time to buy points on a mortgage?
Buying mortgage points can be beneficial to you in the situations listed below:
You know your breakeven point
Breakeven point is the time when the total savings from the reduced monthly mortgage payments equals the upfront cost of purchasing mortgage points. It's the moment at which the investment in points becomes financially beneficial.
If you don’t plan to refinance your mortgage or move away, before reaching this breakeven point, you should buy your points.
You are willing to stay for a long time
Total points you buy on a mortgage will turn out to be an advantage to you only if you plan to stay in your home for a longer time. When you try to switch between houses and get another loan, buying the points on a mortgage won’t work in your favor.
If you are wondering, are these the only situations when I can buy the points on a mortgage?
Well, it depends on more factors like your total mortgage amount, your affordability to buy these points, and the interest rates offered.
To quickly calculate your total loan amount, use the Home Loan Rate of Interest calculator and get an instant mortgage estimate.
We need to also learn about the times when it is not advisable to buy the points on a mortgage.
When not to buy points on a mortgage?
Mortgage points are not for all borrowers out there. Here are some reasons why:
When you have short-term homeownership goals
BIf you anticipate selling your home in a few years, the benefits of paying mortgage points cannot be used to the fullest. If you have short-term housing plans, the expense of purchasing points can be avoided.
While facing financial constraints
If you lack the financial capacity to buy mortgage points without touching your savings, it may not be a practical choice.
Moreover, paying points on a mortgage is not the sole method to save on interest, making additional payments toward your loan's principal balance is an alternative.
If paying a down payment is a priority
In many cases, it may be more beneficial to allocate any extra funds towards your down payment rather than investing in mortgage points.
A larger down payment can lead to a lower interest rate, reduced mortgage insurance costs, or more affordable monthly payments. These advantages are not offered by mortgage points.
You have future refinancing plans
If you intend to refinance your mortgage shortly, buying mortgage points may not be the most strategic move.
To summarize our discussion, the decision to buy mortgage points should align with your specific homeownership plans, financial situation, and long-term goals.
Should you go for it?
If you’re a borrower who has the financial capacity to pay discount points for a mortgage without touching the savings, you can go for it. But before that, understand how monthly payments and tax benefits work while purchasing the mortgage points.
When you’re all into buying a home, it's easy to overlook crucial details while concentrating on interest rates, mortgage payments, and down payments.
So stay proactive when it comes to reviewing your mortgage terms so that you can avoid uncertain surprises later. If you’d like to make such informed decisions regarding your home-buying process, check out our blogs.
