Types of mortgage loans
Which mortgage is right for you? Learn about the different types of home loans and how to choose a mortgage that will fit your needs.
Brandi Marcene
When you’re buying a home, it’s important to get the best interest rates possible. Homebuyers have the option to purchase mortgage points at the time of closing. A mortgage point is a fee paid directly to the lender in exchange for a lower interest rate. As a result, your closing costs will be higher, but you will have a lower monthly mortgage payment. Over time, this may save you money on your home loan.
In this article, we’ll explore the basic mechanics of how mortgage points work and help you to determine whether paying points is a smart financial investment.
A mortgage point, sometimes called a discount point, is a one-time purchase made at the time of closing. Each mortgage point corresponds to a particular reduction in interest. Your lender sets the exact number, but most lenders will offer a reduction of 0.25% of your interest rate for every point. Some companies refer to paying points as “paying down the interest” — essentially, you're buying your rates down with points.
A mortgage point typically equals 1% of your total mortgage amount. For example, on a $200,000 loan, each mortgage discount point is $2,000. When you pay this fee, the lender agrees to reduce the interest rate on your loan.
The number of points you can pay varies according to your lender. Some lenders have a maximum number of points you can use, while others let buyers pay points in increments as small as one-eighth of a point.
To lower the cost of your monthly mortgage payments, you can pay points when your loan is issued.
Each point is typically 1% of your total home loan, so one point on a $100,000 loan is $1,000. You can also pay for fractions of points.
Points are purchased during closing, so they will increase your overall closing cost. Be sure to factor this into your budget when you’re purchasing a home.
Because points are purchased upfront, there are no real long-term costs. To get the best value from your mortgage points, you should not move or refinance prior to your break-even point.
It’s important to understand your break-even point with mortgage points. Prior to this point, the cost of your discount point will be greater than the money you’ve saved. But after this point, your total savings will exceed the upfront cost of your points.
How do you know when you will break even? Imagine that you have a $200,000 loan and you receive an interest rate of 4.5%. If you purchase one mortgage point, your loan rate will be reduced to 4.25%, though it will cost you $2,000 to get that reduced rate.
With this plan, your reduced interest rate would save you approximately $29 per month. To find your break-even point, simply divide your upfront cost by your monthly savings.
In this example, the break-even point will be 69 months ($2,000 divided by $29 per month). With one mortgage point, you will need to spend five years and nine months in your home to receive any value from the discounted rate.
Some lenders may be willing to work on mortgage point fees, so it never hurts to ask for the best available deal during the negotiation process. Here are some steps you can take as you’re comparing lenders:
An annual percentage rate (APR) is a measure of the total cost of the loan per year, taking into account the interest rate, discount points and fees associated with the mortgage. Mortgage discount points are fees you pay to the lender upfront to reduce your interest rate.
Mortgage points and lender credits are essentially mirror images of one another. Mortgage points are paid by the buyer in exchange for a lower interest rate. Lender credits are the reverse: The lender charges a higher interest rate, but you pay less upfront.
Mortgage points tend to be more common, but lender credits can be helpful if you don’t have the cash to cover closing costs or if you want to put that money toward your down payment.
Mortgage points are classified as a form of prepaid mortgage interest and are deductible, according to the IRS.
Typically, a mortgage point will reduce your rate by 0.25%, but this can vary by lender.
No, you can’t get mortgage discount points after closing. Mortgage points reduce your overall interest rate. For this reason, discount points are intended to be purchased before closing.
Mortgage points reduce your interest rate and lower your monthly mortgage payments. But it takes until the break-even point before the real savings start to kick in. Homeowners who expect to move after a few years can actually lose money by purchasing mortgage points.
Mortgage points may be a good idea if you:
Mortgage points are probably not a good idea if you:
For more information about mortgage costs, read next about origination fees.
Which mortgage is right for you? Learn about the different types of home loans and how to choose a mortgage that will fit your needs.
Brandi Marcene
Whether you're buying your first home or you’ve owned for years, there are quite a few deductible expenses, from mortgage interest to property taxes.
Emily Moore
Paying off your mortgage early can save you money on your loan. Learn how this process works and the pros and cons of early repayment.
Jennifer Schurman
Closing costs are lender processing, property and other fees paid to the lender when you close on a home. Learn how they work and how much they are.
Jennifer Schurman
Mortgage-backed securities are investment bonds backed by home loans. Learn more about how they work, the types and considerations.
Jennifer Schurman
Paying biweekly on your mortgage early on can shorten the repayment term on your home loan. Learn how this works and the pros and cons.
Jennifer Schurman
We’ll start sending you the news you need delivered straight to you. We value your privacy. Unsubscribe easily.