Mortgage Points Explained

Understanding Mortgage Points

This is a brief explanation of mortgage points. Many homebuyers, especially first-time homebuyers, wonder "What are mortgage points?" So, hopefully, this brief explanation will help you when working out the details of you home loan.

When you pay "points," you are paying interest upfront. You pay this in a lump sum and in exchange, you get a lower interest rate on a fixed rate mortgage. Basically, each mortgage loan point will cost you 1% of the total mortgage amount. For example, on a home that costs $100,000 one mortgage point would cost $1,000. Obviously, the more points you purchase, the lower your final mortgage rate. Most mortgage lenders offer up to 3 points for purchase. Additionally, each point that your purchase will generally lower the interest rate on your mortgage by 0.25%.

Tip: When lenders advertise mortgage rates, the rate shown is often based on the purchase of mortgage points.

So, now the question: which is the best for you? Should you purchase more points and a secure a lower rate? Or should you keep your cash and go with a higher mortgage rate? To decide, you need to consider two factors:

(1) Whether you can afford to make the upfront payment now for points.Some homebuyers may have difficulty coming up with the additional cash upfront or they may want to hang on to their cash for other expenses.

(2) The length of time expect to have the mortgage. If you plan on keeping your mortgage for a longer period of time, it may make good sense to pay for the points now since you are going to have a longer period of time to benefit from the lower mortgage rate. However, you should speak with a mortgage lender to help you make this decision.

Here is a scenario: Let's say you get an interest rate of 6% on a $100,000 loan. Your monthly payment for principal and interest would be $599.55. If you were to purchase 3 points (at an upfront cost of $3,000) that would lower your interest rate to 5.25% and your monthly payment would be $552.20 per month, a monthly savings of $47.35. Remember, this is for a $100,000 loan. Each point is 1% of the loan. Meaning, 3 points on a $200,000 loan would cost $6,000 and so forth.

Now you can use that scenario to determine the your "break-even" point: How long will you have to live in the house before you get a return on your initial point purchase. In the example above, you would need to keep that mortgage for at least 63 months to get your money back. (cost of upfront points DIVIDED by monthly savings EQUALS length to keep loan).

If you want to determine how much that mortgage will cost per month, check out our online mortgage calculator. You can see exactly how much you will be paying, including your property taxes and homeowners insurance.

This is a very basic explanation and you should always consult a professional lender before making any financial decision.