What Are Points and Should I Pay Them?
When it comes to your mortgage loan, you will hear the word “points” a couple of times during the process. Points are fees paid directly to the lender for processing your loan or reducing your interest rate.
Origination points are paid to your lender for giving you a loan. Discount points give you the ability to lower the interest rate on your loan.
In most cases, a point equals 1% of your mortgage loan.
Origination points
Origination is the business term used to describe your loan process. This includes underwriting your loan, processing all of your paperwork, and closing on your loan. Your lender gets paid through origination points and through the interest you will pay over the life of your loan as part of your mortgage payment.
The number of points you pay is not set in stone, and you may be able to talk to your lender about reducing the number of points in order to reduce the amount you pay.
If an origination point equals 1% of the loan amount and the mortgage company is asking for 1.5 origination points, the origination points for a $250,000 loan = $3,750.
At tax time, origination points are not tax deductible if they also include closing costs or other fees. The points must be used for the purchase or build of your primary residence, and you have to pay them directly, meaning you can’t negotiate to have them included in your loan amount or paid by someone else at closing.
Discount points
In general, a discount point gives you the ability to buy a lower interest rate by pre-paying some of your interest. If you’re not able to get a lower interest rate because of your credit score, you may still be able to take advantage of lower rates by paying for points. Each point will lower your interest rate by a certain percentage or fraction of a percentage. Your lender will establish the maximum number of points you can purchase.
When weighing the pros and cons of paying for discount points, you should take into consideration how long you plan on being in your home and having the mortgage.
Because interest is calculated based on a specific term (number of months) that you will be making payments, reducing your interest rate by pre-paying interest may not be a good idea if you’re planning on selling or refinancing your loan within a few years of getting it. You’ll see the benefit of discount points the longer you’re making payments.
How points work
ABC Mortgage, a hypothetical lender, will reduce your interest rate by .25% for each point you purchase and they will allow you to purchase up to 3 points. Each point costs 1% of your loan amount. You are getting a $250,000 loan, and you were offered an interest rate of 4%. The monthly principal and interest payment would be $1,193.54.
If you purchase a discount point, you can reduce your interest rate to 3.75%. Your principal and interest payment would be $1,157.79 per month. You will pay $2,500 for the points and receive a $35.75 savings per month in interest.
Questions to ask yourself
Are Points Worth the Cost?
You would have to make about 70 mortgage payments (5.83 years) to recoup the $2,500. If you sell or refinance before that point, you won’t get to see the benefit of your points purchase. If you’re planning on staying in your home long-term, you’ll pay less in interest over the life of your loan than if you hadn’t purchased points.
This is assuming that your home value stays the same. If your home value increases, the increase in value may offset any savings loss you’d see by selling or refinancing within the first five years of ownership.
Can I Afford It?
Another thing to consider is the price itself. The $2,500 for points is on top of your down payment and other closing costs. If you qualify for a low- or no- down payment loan, the additional cost for points may be something you can afford.
When it comes to making a decision on purchasing discount points, it comes down to how long you plan on staying in your home to see the long term savings, and if you can afford the up-front cost.
The bottom line – if your lender decides to charge you origination points, these are to some extent, negotiable, but not optional.
Discount points are completely optional for the homebuyer. Some lenders don’t charge origination points, but rather a flat origination fee. In this case, you wouldn’t have origination points, but would still have the option to utilize discount points.