Mortgage points are various costs or fees that are paid when taking out a mortgage loan. Their value is based on the size of the mortgage loan and they have an influence on what your interest rate will be. Mortgage points are essentially a form of interest that is paid before you start making payments on your mortgage loan. Acquiring a mortgage loan can be an expensive and complicated process, but an explanation of mortgage points may make things a little easier and save you money in the long run.
What are Mortgage Points?
There are two types of mortgage points: discount points and origination points. One point equals 1 percent of the total loan amount. For example, on a $200,000 loan, one point is $2000, which is 1 percent of the total amount borrowed.
Origination points are paid to lenders in order to compensate them for their role in processing and approving your mortgage loan. Your credit history plays an important part in the number of points that you will have to pay to your lender. You can negotiate how many origination points you will be required to pay, but origination points are not tax deductible.
The points that will have a bigger impact on how much you will spend on your mortgage loan are discount points. Equal to 1 percent of your mortgage loan amount, one discount point will reduce your interest rate by 0.25 percent. Usually, lenders allow you to purchase anywhere from 0 to 3 discount points. So discount points are a form of pre-paid interest, which can help you pay less on your loan over its lifetime.
Are Mortgage Points Worth Paying for?
When you consider purchasing discount points, you must take two factors into account. The first is how long you are planning on living in your new home. Because discount points reduce your loan’s interest rate, the more you live in your home and keep making payments, the more you will save. If you plan on moving after only a few years, then paying for fewer points or even none is generally a better choice.
The second factor that you should take into consideration when deciding whether to pay for discount points has to do with your ability to pay for them. Between the large down payment and closing costs, buying a home is a pretty large investment, and sometimes there simply isn’t enough money left to purchase mortgage points. Because points are based on a percentage of the total loan amount, buying a cheaper home means that points will be more affordable as well. But with more expensive homes, such as a $400,000 home, three discount points will cost you $12,000, which is not exactly cheap, especially when you have to pay several other fees and the down payment on the closing day.
Whether it’s worth paying for mortgage points or not depends on your future plans and budget. If you do your homework and calculate how much your mortgage will cost you with and without points, you will generally find that paying for points is a good investment that will save you a considerable amount of money.
You won’t see any huge savings on interest month to month after purchasing points, but, after a 30 year loan period, those savings will add up to tens of thousands of dollars. Of course, before choosing to pay for mortgage points, you should carefully analyze your finances while taking into account the two deciding factors.