“Points” as they are referred to in the real estate industry are simply another type of fee paid by you at closing to your mortgage lender. There are two types of points often associated with a mortgage; origination points and discount points. Simply put, a “point” is equal to 1% of your loan amount. For example, on a $100,000 mortgage loan, 1 point would cost you a total $1,000. Not all loans necessarily require that you pay points; however there may be advantages to paying one type of point over another based on your current tax situation, so it’s certainly worth a more detailed discussion.
The difference between the two types of points is where they are applied. Origination points are often charged by the mortgage lender to recover some of their costs of the loan origination process. Oftentimes your loan officer’s compensation is based on origination points, and if they charge you more, they get paid more. However, that’s not always the case, as some loan officers are paid based on their overall loan volume, and work for lenders that don’t charge origination points at all. So it definitely pays to shop around with multiple lenders, compare rates and origination costs, and be well informed before making a decision.
In contrast, a “discount point” is a form of prepaid interest on the loan, and so points that are paid up front to your lender will reduce your interest rate and corresponding monthly payment. Each point purchased will generally lower your interest rate by 0.25%, and so the more points you pay, the lower your interest rate will be. Most mortgage lenders will allow you to purchase up to three discount points, and depending on your situation, it may be a good idea to consider.
These points lower the interest rate for the entire term of the loan, so if you think you will be in the house for a long time, paying points to reduce the interest rate is oftentimes a very good decision. For example, if you were looking at a 30 year fixed mortgage loan for $165,000 at 6% interest with 0 points, your monthly principal and interest payment would be $989. If you purchased two points for $3,300 your interest rate would be 5.5% and your monthly principal and interest payment would be $937; a savings of $52 per month. You would have to keep this loan for 64 months (over 5 years) for you to earn back the $3,300 you paid for the upfront points. If you plan on being in the home for more than 64 months, you would make a return on your initial investment. However, if you sold the home or paid off the mortgage before then, it would not have been a good investment.
Another reason you might decide to pay points would be to reduce your payment in order to help you qualify for your mortgage in the first place. Qualifying for a loan is based on monthly income versus the monthly payment, and sometimes a buyer might find that the only way to keep their monthly debt-to- income ratios in line is by reducing the monthly payment by purchasing discount points. This reduced payment may make the difference between being approved or denied for the loan, which can oftentimes be the most important thing to a buyer who is excited about their home purchase, much more so than a ¼ point on an interest rate.
So, is it worth it for you to pay “points” on your mortgage? The information above, along with consulting your real estate professional and mortgage originator, should help you make a sound financial decision. While some of the terminology involved in a home purchase may be overwhelming and confusing, hopefully this article will at least make the discussion regarding “points” a little easier to understand. Doing your research and staying armed with knowledge is the best way to make sure you are not taken advantage of in the marketplace, and that you get the best possible deal for you and your family.
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