What Are Mortgage Points and How Do They Work?

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There’s a lot to learn when it comes to buying a house, especially if you’re going through everything for the first time. While you might already be aware of some of the basics, such as what a down payment is or how lender fees work, other topics like mortgage points may not actually come up until you’re knee-deep in the homebuying process.

Below, Select takes a closer look at what mortgage points are and how they can potentially save you some serious money over the life of your loan.

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What are mortgage points?

Mortgage points are fees a homebuyer can pay upfront in exchange for a slightly lower interest rate. This is also referred to as “buying down the rate,” and is something that could potentially save you a lot of money over the life of your loan.

As with any other form of debt, interest charges can really eat into your budget and make it more costly to borrow money — especially when you need to take on such a large loan to pay for your house — so, it’s easy to see why purchasing mortgage points can help you save some money in the long-run.

How do mortgage points work?

How much money can you save from mortgage points?

The amount of money you’ll save over the life of your loan depends on how much of a loan you’re taking on, how many mortgage points you’re buying upfront, what your interest rate reduction is and the length of your loan term.

Bank of America illustrates a savings example with a $200,000 loan at a 4.5% interest rate over the course of 30 years — in this case, no mortgage points were purchased so the individual will pay $1,013.37 per month in interest and principal over the 30-year period. According to the example, however, if a homebuyer was to purchase one mortgage point for $2,000, they’d reduce their interest rate to 4.25% and instead of having to pay $1,013.37 per month, would only pay $983.88 per month. That amounts to a total of $10,616.40 in interest savings over the 30-year period. When you incorporate the $2,000 cost of the mortgage point, you’d end up with a net savings of $8,616.40.

The amount of savings essentially doubles over the 30-year period when a homebuyer purchases two mortgage points instead of one — paying $4,000 upfront for two mortgage points would lower the interest rate to 4% and change the monthly payment from $983.88 to $954.83. Over 30 years, this homebuyer would end up saving $21,074.40. When you incorporate the $4,000 cost of two mortgage points, you’d end up with a net savings of $17,074.40 over 30 years. In this example, it would take 68 months of payments to break even to cover the $4,000 cost of purchasing the mortgage points.

Of course, you’ll need to run your own numbers once you know how much of a loan you’ll need and what your interest rate will be — your lender can help you determine these calculations so you can better project what your savings would look like. Also, it may make more sense to put more money down on the house versus purchasing mortgage points.

Is paying for mortgage points worth it?

As we saw in the example above, mortgage points can save homebuyers a considerable amount of money in the long-term. Plus, they can potentially offer tax benefits, as you can deduct mortgage interest payments from your taxes. Buying points upfront can be worth it if you plan on staying in the same home for the entirety of your loan, or at least long enough for you to break even on the amount of money you paid for them — remember to ask your lender to help you calculate your exact break-even point.

If, however, you only plan on staying in the home for a short amount of time, paying for mortgage points upfront may not be worth it. It also might not make sense to do this if you plan on refinancing your mortgage soon after buying since refinancing essentially replaces your current interest rate.

Purchasing mortgage points would be helpful if you applied for your loan with a lower credit score but weren’t able to snag a more favorable interest rate. Keep in mind, however, that these should not be treated as your plan A when it comes to lowering your interest rate; mortgage points are best used in conjunction with a favorable interest rate, which you’d receive by having a higher credit score.

It’s also worth considering whether or not you have enough extra cash on hand to pay for mortgage points, as the down payment, closing costs and other fees you’ll encounter during the homebuying process can really add up. On top of that, you’ll want to ensure you have enough money saved up on the sidelines for any immediate home repairs or emergencies that may arise after you move in.

Finally, the cash you use to purchase mortgage points may be better used towards putting more money down when you’re buying your house — as you’ll immediately have more equity in the home and will have to borrow less money to purchase it. You can use a mortgage point calculator to better understand where your money would go if you put more down or purchase mortgage points.

Keep in mind that mortgage points work best if you have a fixed-rate mortgage. If you have an adjustable-rate mortgage, they’d only be used to lower your interest rate during the fixed-rate period for the first few years but wouldn’t apply to the remainder of the loan, so you wouldn’t have a long time horizon to enjoy those savings.

If you think you might be interested in purchasing mortgage points, talk to your lender to see if it’s an option they offer. Lenders will typically have a variety of other terms and programs aimed at providing more flexibility for borrowers. For example, Ally Bank provides home loans with no lender fees so you won’t have to pay for the application, origination, processing or underwriting. This can help borrowers save a little money and potentially put it toward other homebuying costs instead.

Ally Bank

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included

  • Types of loans

    Conventional loans, HomeReady loan and Jumbo loans

  • Terms

  • Credit needed

  • Minimum down payment

    3% if moving forward with a HomeReady loan

Pros

  • Ally HomeReady loan allows for a slightly smaller downpayment at 3%
  • Pre-approval in just three minutes
  • Application submission in as little as 15 minutes
  • Online support available
  • Existing Ally customers can receive a discount that gets applied to closing costs
  • Doesn’t charge lender fees

Cons

  • Doesn’t offer FHA loans, USDA loans, VA loans or HELOCs
  • Mortgage loans are not available in Hawaii, Nevada, New Hampshire, or New York

For those who happen to reside in a higher cost of living area and need to borrow more money to buy their homes, SoFi offers jumbo loans to fund as much as $3 million.

SoFi

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included

  • Types of loans

    Conventional loans, jumbo loans, HELOCs

  • Terms

  • Credit needed

  • Minimum down payment

Pros

  • Fast pre-qualification
  • Provides access to Mortgage Loan Officers for guidance
  • $500 discount for existing SoFi members
  • 0.25% price reduction when you lock in a 30-year rate for a conventional loan
  • Offers up to $9,500 cash back if you purchase a home through the SoFi Real Estate Center

Cons

  • Doesn’t offer FHA, VA or USDA loans
  • Mortgage loans are not available in Hawaii

Bottom line

Purchasing mortgage points can be a clever way for homeowners to buy down their interest rates and save money in the long-run. That said, this method only makes the most sense if you plan on staying in your home for a long period of time — and if you have the extra cash on hand to buy them upfront.

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.



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