When homebuyers begin to think about mortgages, inevitably they get around to discussing "points" and whether or not to pay them on their mortgage. To make a wise decision, it's important to understand what points are and how they affect your rate and closing costs.
A point is equal to 1% of the total amount of the mortgage. There are two types of points: "origination points" and "discount points." Lenders charge origination points to cover the expenses associated with underwriting the loan, while discount points are designed to reduce the loan's interest rate.
Discount points are actually prepaid interest that you give the lender when you take out a loan. Each point typically lowers your interest rate by one-eighth of a percentage point, though actual rate reductions can vary by lender and market conditions.
As a rule, the more discount points you pay, the lower the interest rate on your mortgage will be. On the other hand, the more points you pay, the more cash you will need because points are paid in cash at closing. This is why they are referred to as a "discount": you pay upfront for a reduced rate over the life of the loan.
Although points are usually paid at closing, some lenders may agree to finance points along with the rest of the loan. Be aware that lenders advertising low interest rates may charge more for their points, so compare total costs carefully and review resources such as Understanding the Impact of Credit Scores on Mortgages if your income or credit profile may affect the options available to you.
How should a homebuyer decide whether or not to pay points? Sometimes the answer is decided for you by your financial situation. If you are short on up-front cash, or your income is near the lower limit of what a lender requires, you will need to avoid points so you have enough money to fund closing costs and reserves.
If you have some extra cash on hand but your income is the limiting factor for loan approval, it's usually necessary to find the lowest rate available so the mortgage payment won't be viewed as too large relative to your income level.
If you aren't constrained by cash or income limits, then decide based on two factors. The first is time: if you expect to hold the mortgage long term (commonly seven to ten years), paying points to reduce the rate can be a good idea; if you plan to sell or refinance before that, paying the higher rate may be better.
The second factor is opportunity cost: will paying points mean tapping funds earmarked for other priorities such as retirement or an emergency savings cushion? Consider whether you have enough time and financial flexibility to recover the long-term savings from a lower rate.
Before you make a final decision about points, find out what interest rate you will pay and what the points will cost on each mortgage you are considering. Compare loans side-by-side so you can see which offers the better deal, and consult general guides like Understanding Home Loans and Mortgages to help interpret loan terms and costs.
Finally, evaluate whether you will have enough available cash on hand to take advantage of opportunities or meet unexpected emergencies if you pay for points. By taking the time to compare costs and consider your financial priorities, you can make an informed decision on whether purchasing points is right for you.
Frequently Asked Questions
What is a mortgage point?
A mortgage point is equal to 1% of the loan amount and is paid up front to lower the loan's interest rate or to cover lender fees.
What is the difference between origination points and discount points?
Origination points cover lender fees for processing the loan, while discount points are prepaid interest paid to reduce the mortgage rate.
How much does one point reduce the interest rate?
One point commonly lowers the interest rate by about one-eighth of a percentage point, but the exact amount varies by lender and market conditions.
How do I decide whether paying points is worth it?
Compare the up-front cost of points to the monthly interest savings and estimate how long you will keep the loan to see if you reach a break-even point.