What Are Mortgage Points?

Should you consider buying mortgage points for your next house? Borrowers buy mortgage points in exchange for lower interest rates that help to decrease monthly mortgage payments. With options to purchase whole points or fractions of points, a rate buydown is more flexible than most borrowers know. 

Who benefits from buying mortgage points?

When loan shopping, mortgage points help to reduce interest rates, thus monthly payments for the life of your loan. They’re ideal for buyers who plan to stay in a home for a long time. Additionally, the ideal candidate is someone who feels confident enough in their loan terms and conditions to believe they’ll stick with their current loan instead of refinancing.

The main motivation behind buying mortgage points is reducing your monthly mortgage payment. You’re willing to pay extra at closing for the perk of having more manageable payments for the next 15 to 30 years.

How to calculate the benefit of points

In order to see if buying mortgage points help you, you have to calculate your break-even point. Let’s cover exactly how mortgage points work first.

• A mortgage point typically costs 1% of the total loan amount. That’s one point for $3,000 if you’re getting a $300,000 mortgage. Each point purchased brings the mortgage interest rate down by 0.25%

Let’s say the $300,000 mortgage you’re being offered comes with a 6% interest rate on a 30-year term. If you purchase two mortgage points for a total of $6,000 ($3,000 x 2), your interest rate would come down to 5.5%.

Without accounting for taxes or insurance, this 6% rate gives a monthly mortgage payment of $1,799. Purchasing two points to drop the rate down to 5.5% brings your monthly payment to $1,703. This represents a savings of $96 per month.

To determine your break-even point, divide the upfront cost of your points by your monthly savings. It will look like this:

• $6,000/$96 = 62.5

This means that you’ll need to spend roughly 63 months (five years) in your home before you’ll break even to the point where purchasing the mortgage points was worth it. If you plan to stay in your home longer than five years, you’ll save close to $100 a month for the remainder of your mortgage. 

How many points can you buy?

It depends on your lender. There’s no set limit. However, most lenders cap your buydown potential at four points. Mortgage points can be bought with a variety of home loans. Even FHA borrowers can buy them.

You may be able to pay nothing for your mortgage points if you can get them included in your seller’s purchase concessions.

When to avoid a rate buydown

Bringing down your monthly payment isn’t always the best choice if it’s going to force you to pay for mortgage points. You may not make that money back if you aren’t staying in a home for a long time. If your goal for buying a home involves eventually relocating or trading up a starter home for a better home, it might be better to save the money you’d spend on mortgage points instead.

The same goes if you plan to refinance. If you don’t necessarily feel like you want to marry today’s mortgage rate, you may be planning to refinance as soon as it makes sense based on future interest rates and your home equity. 

While paying money to get your interest rates lower for now will lower your monthly mortgage payments, you may not save enough per month to justify what you’ll spend to purchase the points. Consider skipping mortgage points if:

• You’re selling in a few years.
  
• You plan to make extra mortgage payments to pay off your loan ahead of schedule.
  
• You’d need to drain your savings to purchase points.
  
• You’ll need to put down a smaller down payment to afford points.

Alternatives to rate buydowns

A mortgage point buydown isn’t the only way to save money on your mortgage. Before paying for points, always check to see if simply putting down a larger down payment will reduce your monthly payments enough to make mortgage points unnecessary. Putting down a higher down payment can also help you avoid private mortgage insurance (PMI) payments. 

Additionally, making larger payments with a 15-year mortgage in order to get a lower interest rate while paying off your loan sooner could save you much more than buying points in the long run. If mortgage points won’t benefit you because you’re only planning to stay in a home for a short time, consider an adjustable-rate (ARM) mortgage that will give you a low introductory interest rate while you carry the mortgage before selling.