What Do Mortgage Points Do?
The process of buying mortgage points is often called “buying down the interest rate” or a “buydown.” When you buy mortgage points, you pay a certain percentage of the loan amount that is determined by the market. For example, the cost of buying a point on a mortgage might be 1 percent of the loan amount; so, on a $300,000 mortgage in this example, one point would be $3,000.
Mortgage points are like prepaid interest, letting you lower your loan's interest rate. The value of a mortgage point is determined by the market and brings down the overall rate. For example, if a mortgage point is set at 0.25 percent, it would bring a 6.5 percent mortgage rate down to 6.25 percent. Note, the reduction in the rate can vary—it is determined by the market. The effectiveness of points also depends on the type of mortgage and the current interest rate environment.
While it is most common to buy down your interest rate with points, you could also opt for a higher interest rate in order to get credit for the points in cash. This could help you if you need additional cash on hand to help with closing costs or a more substantial down payment.
If the market currently has higher interest rates, it may take longer to recover the upfront cost of the points. The type of mortgage also matters because different types of mortgages have varying implications for the effectiveness of points. For example, in a fixed-rate mortgage, paying points upfront can help reduce the overall interest paid over the life of the loan, making it a potentially good investment. On the other hand, in an adjustable-rate mortgage, the benefits of paying points may be less predictable due to the fluctuating nature of interest rates.
If you're thinking about getting points, make sure to ask your lender for specific details. The cost of points is paid at the closing, and it will be itemized in the loan estimate document, as well as the closing disclosure. It's important to know that both your lender and the market decide your rate reduction, and it can change after the fixed-rate period for your mortgage ends. This timeline is often between 10 and 30 years.
Should You Buy Mortgage Points?
Buying points to lower your monthly mortgage payments might be a good idea if you choose a fixed-rate mortgage and plan to own the home beyond the break-even point. The break-even point is the time it takes to recover the cost of buying the points through savings in interest.
To calculate the break-even point, divide the cost of the mortgage points by the amount the reduced rate saves each month. For example, a mortgage valued at $300,000 with a 7% interest rate would mean the monthly payment is roughly $1,996. Purchasing one mortgage point would lower the rate to 6.75%, reducing the monthly payment to $1,945, a difference of $51. You would take that number and divide it against the cost of the point, so in this case, 3,000 divided by 51, which results in around 59. That means, on a fixed-rate mortgage, a homeowner needs to own the home for 59 months to recover the cost of the point.
While mortgage points have some great benefits, if you plan to sell or refinance your home before the break-even point, you won’t get the financial benefits. There are also more upfront costs you'll have to pay, which would increase the initial costs of your mortgage.
If you plan to live in the home for a long time, or you aren’t planning to refinance, then buying mortgage points may make sense. Just make sure to calculate whether the money you may use for points makes more sense for something else, like a bigger down payment. A larger down payment could have benefits such as lowering your interest rate, reducing the amount owed on a loan, or making monthly payments more manageable.
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