Getting a mortgage can be a complex process. There are so many lenders out there, and you obviously want to find the one that offers you the lowest interest rate. Further complicating matters are mortgage points, which can affect your mortgage and your closing costs. Here’s what you need to know about them.
Financing a Home Using Mortgage Points
When you want to purchase a home but you don’t have the money to pay for it in full, you can apply for a mortgage through a lender. During the process of applying for a mortgage, your lender will likely bring up mortgage points.
Types of Mortgage Points
There are two types of mortgage points: discount points and origination points. Each type of point works very differently. The only similarity between the two is that with each type, one point is equal to 1 percent of the total mortgage amount. On a $200,000 mortgage, each point is 2 percent.
Discount points are a way of paying a small portion of your mortgage’s interest upfront, which will then lower your interest rate for the lifespan of the mortgage. The amount your annual percentage rate (APR) will go down depends on how many points you use and the lender. These types of points are tax deductible.
You can also take the opposite approach and get negative discount points on a mortgage. This means that you’re increasing your interest rate in exchange for lower upfront costs. It’s a good idea to avoid doing this whenever possible, though, because you don’t want to increase your interest on a mortgage.
Origination points are the amount that your lender charges you for setting up your mortgage. The lender will base the number of points you need to pay partially on your credit history. If the lender charges you 2 points in origination fees on a $200,000 mortgage, you’ll end up paying $4,000. These types of points are not tax deductible.
Benefit of Using Discount Points
You benefit by using discount points because you lower your interest rate, which can save you a substantial amount of money over the lifespan of your mortgage. Here’s an example, using that same mortgage amount of $200,000: You spend $4,000 upfront to purchase 2 mortgage discount points, and in return, the lender reduces your APR from 4.5 percent to 4 percent. You have a 30-year mortgage, and your monthly payment drops from $1,013 to $955, saving you $58 per month. Although you’ll lose money in the beginning, over the entire 30-year term, that $58 per month will save you over $20,000, meaning you come out $16,000 ahead.
Benefit of Using Origination Points
You don’t get much of a say in origination points, since the lender is going to charge these regardless. There are lenders that don’t charge origination points or any origination fees, but the problem is that you’ll end up paying more in interest over the term of the loan.
The upside of going with a lender that uses origination points is that it makes it easy for you to determine how much your mortgage’s origination costs are going to be. Just take the number of points and multiply your mortgage total by that percentage.
Are Buying Points Worth It?
If you’re in the middle of the mortgage process, the million-dollar question is whether you should purchase discount points to lower your interest rate. One way to figure this out is by determining your break-even point on your initial investment, which in this case is the money you pay to buy those points. Let’s go back to the prior example where you save $58 per month for buying 2 points upfront at $2,000 per point. Saving that much money per month, it will take you 69 months before you’ve broken even, a little under six years. Now, you just need to figure out if you plan to live in the home for that long. If you plan to keep your home for decades, spending money upfront for mortgage points is a smart decision that can save you quite a bit by the time you finish paying off the mortgage. On the other hand, if you plan to keep a home for a few years and then sell it, you’re most likely better off saving your money instead of opting for the points.
Understanding mortgage points is a key aspect of choosing the right lender and getting the best deal on your mortgage. By knowing how much of a discount lenders offer through their discount points and how much they’ll charge in origination points, you can run the numbers and see where you can really get the lowest rate.