If you are beginning to look into obtaining a mortgage, you may have heard of mortgage points. Mortgage points are an upfront charge on your loan. A mortgage point is equal to 1% of the loan amount. So if you are taking out a loan for $200,000 1 mortgage point would be equal to $2,000. There are two types of mortgage points so it’s important to understand the difference between discount points and origination points.
Origination points are a fee that is added to your loan amount by the lender. They are basically a way to pay for closing costs. Some mortgage lenders charge points, others do not. On average most lenders charge a 1 origination point. Origination points are not tax deductible.
Discount points represent a fee that is paid to the lender in an effort to lower your interest rate and ultimately your monthly payment. Discount points are a way for the borrower to make an upfront payment towards the interest on their loan. For doing so the interest rate over the life of their loan is reduced.
An article on DaveRamsey.com outlines what this could look like for a borrower.
To help this all make sense, let’s break it down. Suppose you’re buying a $300,000 house. You have a 20% down payment and are taking out a 30-year fixed-rate conventional loan of $240,000 at a 4.5% interest rate.
To lower the interest rate, you pay your lender for one mortgage point at closing, and assuming that point equals 1% of your loan amount, it will cost $2,400.
$240,000 loan amount x 1% = $2,400 mortgage point payment
After you buy the mortgage point, your lender reduces the interest rate of your mortgage by, say, a quarter of a percent. That takes your interest rate from 4.5% to 4.25%.
This slightly lowers your monthly payment from $1,562 to $1,526—which is $36 less a month on a fixed-rate conventional mortgage.What Are Mortgage Points and How Do They Work? – DaveRamsey.com
Discount Point Considerations
If you are thinking about buying points it’s important to determine how this will benefit you. Lowering your monthly payment is great, but remember you are paying interest up front in order to decrease the monthly payment. Buying points up front can save you thousands in the long run. According to the Dave Ramsey example above he goes on to outline the savings over the life of the loan.
Without any mortgage points, you’ll pay a total of $197,778 in interest. With one mortgage point, you’ll drop that amount to $185,035—which saves you $12,743 in total interest.
$197,778 original total interest paid – $185,035 reduced total interest paid = $12,743 amount saved
But when you account for the $2,400 you paid for the mortgage point, you really only saved $10,343.
$12,743 interest savings – $2,400 mortgage point = $10,343 true savings
However the most important factor to consider in this equation is how long are you likely to stay in the home. You will need to stay in the home long enough for the decreased payment to equal the prepayment amount. In this example you would need to live in the home for 5 years and 7 months without refinancing in order to use up the prepaid interest. Until that point you won’t really be seeing a savings.
Ultimately making the decision to buy discount points on your mortgage can save you a significant amount over the life of the loan. However if you don’t know how long you will stay in the home or think you would consider refinancing in the future, it may not be a smart choice.
At Title Mortgage Solution our team of Loan Officers can fully explain the benefits and draw backs of discount points on your mortgage and help you decide if this is something you’d like to do. Our goal is to work with our clients closely in an effort to get them the best mortgage available.
Contact our office today at 603-643-1400 to get connected with a loan officer who can help you navigate the mortgage lending process.