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Since purchasing a home is typically the most expensive purchase a person will ever make, anything that can lower the cost of a mortgage is obviously worth investigating. Some homebuyers choose to purchase mortgage points, also known as “discount points,” to reduce the amount of interest they pay in addition to negotiating a fair price and looking for the best mortgage rates.
What are mortgage points and how do they work?
The fees a borrower pays a mortgage lender in order to lower the interest rate on the loan are known as mortgage points. This is sometimes called “buying down the rate. “Each point a borrower purchases costs 1% of the mortgage balance. So, one point on a $300,000 mortgage would cost $3,000.
Each point typically lowers the rate by 0. One point would reduce a mortgage rate from 4% to 3%, or by 25%. 75 percent for the life of the loan. However, lenders differ in the amount that each point reduces the rate. The type of mortgage loan and the general interest rate environment have an impact on the rate-reducing ability of mortgage points.
More than one point, as well as fractions of a point, can be purchased by borrowers. For instance, a half-point on a $300,000 mortgage would cost $1,500 and reduce the interest rate by roughly 0. 125 percent.
The loan estimate document, which applicants receive after submitting an application for a mortgage, and the closing disclosure, which applicants receive prior to the loan’s closing, both list the points that will be paid at closing.
Mortgage origination points are another type of mortgage points. They are costs incurred by lenders to initiate, examine, and complete the loan Origination points typically cost 1 percent of the total mortgage. So, if a lender charges 1. On a mortgage for $250,000, the borrower is required to pay $4,125 in origination points.
Origination points are distinct from discount points in that they do not immediately lower the loan’s interest rate. Some lenders permit borrowers to obtain a loan with no closing costs or origination points or with fewer of them, but they make up the difference with higher interest rates or other fees.
Mortgage discount points are a type of prepaid interest. When you pay for these points, you typically lower your loan’s interest rate by 0 25% per point. Frequently, you can buy anything from a single point to three points and possibly more.
You can decrease the monthly payment by lowering the interest rate on the loan. However, keep in mind that this requires an upfront payment. Generally, the more benefit you’ll receive from paying for points, the longer you intend to live in a home.
Mortgage discount points vs. APR
APR comparisons can help you compare loans with various rate and point combinations. Purchasing discount points on your mortgage effectively allows you to prepay some of your interest. The APR includes the interest rate, the points you pay, and any additional fees the lender may impose in addition to the interest rate. See Greg McBride, CFA, Bankrate’s chief financial analyst, for a succinct explanation:
Example of how mortgage points can cut interest costs
You can lower your monthly mortgage payments and potentially save a lot of money if you can afford to purchase discount points in addition to the down payment and closing costs. Staying put long enough to recoup the prepaid interest is crucial. Purchasing discount points might result in a loss of money if you sell the house after a brief period of time, refinance the loan, or pay it off.
As an illustration, consider the cost savings that discount points can make on a $200,000, 30-year, fixed-rate mortgage:
In this instance, the borrower purchased two discount points for a total of $2,000, or one percent of the loan’s principal. The borrower’s interest rate dropped to 3 by purchasing two points for $4,000 up front. 5 percent, resulting in a $56 monthly payment reduction and a $20,680 interest cost savings over the loan’s term. (However, the borrower would have to stay in the house for the entire 30-year loan term and never refinance in order to save the full $20,680. ).
What is the breakeven point?
Divide the cost of the mortgage points by the monthly savings from the lower rate to determine the “breakeven point” at which this borrower will recoup the money spent on prepaid interest:
This demonstrates that for the borrower to recoup the cost of the discount points, they would need to own the property for 71 months, or almost six years.
According to Jackie Boies, senior director of partner relations for Money Management International, a nonprofit debt counseling organization based in Sugar Land, Texas, “The added cost of mortgage points to lower your interest rate makes sense if you plan to keep the home for a long period of time.” “If not, the likelihood of recouping this cost is slim. ”.
To determine whether purchasing mortgage points will result in cost savings, use Bankrate’s amortization and mortgage points calculators.
Are mortgage points right for you?
Purchasing mortgage points is a way to make an upfront payment to lower your loan’s total cost and lower your monthly payment. If you intend to reside in the house for an extended period of time, it makes the most sense. The monthly savings will probably outweigh the initial expense.
Of course, paying points is probably going to cost you money in the long run if you don’t intend to live in a home for a long time.
Whether to spend money on points or a larger down payment is another factor to take into account. You can frequently obtain a lower interest rate by making a larger down payment anyway. Additionally, reaching the 20% down payment threshold may enable you to avoid paying the additional PMI fees.
Your loan-to-value ratio, or LTV, or the amount of your mortgage in relation to the value of your home, will be lower if you make a larger down payment.
Before purchasing mortgage points, borrowers should take into account all the variables that could affect how long they intend to live in the house, including the size, location, and their employment situation.
Frequently asked questions about buying mortgage points
What is the difference between origination fee and discount points?
For granting you a loan, your lender will receive origination points. You can reduce your loan’s interest rate by using discount points. A point typically corresponds to 1% of your mortgage loan.
What is a 2 point origination fee?
An upfront payment known as a discount point lowers your interest rate. 1 Origination fees compensate your lender for closing your loan. Confusion is increased by the informal use of the word “points” to denote a percentage of the loan amount. This means that “two points” would equal 2% of the loan’s total amount.
Are lenders fees the same as points?
Like points, lender credits operate in a similar manner but in reverse. The lender gives you money to cover your closing costs in exchange for you paying a higher interest rate. When you receive lender credits, you pay less up front, but the higher interest rate means that you pay more over time.
Is the loan origination fee negotiable?
Although this fee covers a variety of loan-related services, it is frequently negotiable. In particular, if you’re a first-time home buyer, never be afraid to ask your lender for a reduction or credit to offset your costs. Common expenses for covering your lender’s work in processing your loan are loan origination fees.