What Are They?
Mortgage points are fees, expressed as a percentage of the loan, which the borrower pays at settlement.
There are two types of Mortgage Points:
- Discount Points - Discount points are fees that a borrower can purchase and pay at closing that lower the interest rate of the loan. When a borrower purchases discount points they are essentially prepaying a portion of the interest on their loan in exchange for a lower rate, which then lowers the monthly payment. One point is equal to 1% of the total loan amount and typically lowers the interest rate by 0.25%. For example, one point for a $200,000 loan would cost $2,000. If the interest rate on the loan is 6.00% and the borrower purchases three point for $6,000 the interest rate would decrease by 0.75%, lowering the rate to 5.25%.
- Origination Fees - An origination fee is a one-time, compensation fee paid at closing to the lender or bank for evaluating and processing the loan. Origination fees are also expressed as a percentage of the loan amount and can vary depending on the lender. These fees can sometimes be negotiated, but generally, one origination point is equal to one percent of the total loan amount.
Deciding to purchase mortgage points can vary by individual. When considering if purchasing mortgage points is right for you, first evaluate your financial situation to determine if you have the funds and if you want to spend those funds to purchase points. In addition, you should consider the length of time you plan to stay in the home, how long you will have the loan and how long it will take you to “break even” or recoup the money you spent to purchase the points.
To calculate your breakeven point, take the amount you paid for the points on your mortgage and divide the number by your monthly interest savings to give you the number of months it will take you to recoup your loan points. Then divide that number by 12 which will give you the number of years it will take to break even.
If you borrowed $250,000, one point would cost $2,500, decreasing the rate by 0.25%.
If your rate with no points was 4.50%, your monthly payment would be $1,266.71.
If you purchased one loan point, your rate would decrease to 4.25% and your monthly payment would be $1,229.85.
Calculate the difference of the two monthly payments ($1,266.71 minus $1,229.85 = $36.86/month).
Then, take the total cost of the points purchased and divide by the monthly savings, which will give you the number of months it will take to break even. ($2,500/$36.86= 67.82)
Finally take the number of months and divide by 12 which will give you the number of years it will take you to break even (67.82/12 = 5.7) *Important Note: always round this number up.
In this situation, the borrower would need to live in the house or keep the loan for 6 years in order to break even or earn back the money spent to purchase the mortgage points.