How points work on a mortgage?

 

Many home buyers are adverse to paying "points". Some buyers think mortgage points are a sinister plot to extract extra money from the customer, or just an extra expense. Here's a down to earth explanation of mortgage discount points; also known as origination fees. The mortgage lender can offer you a lower interest rate if you are willing to PRE-PAY some of the interest at closing, called "points".

No mortgage points ban signLet’s say the mortgage lender wants to earn $100,000 interest over the life of the loan, so the loan officer offers you a ZERO point rate of 6% and will earn $100,000 over the life of the loan, or the lender could offer you an interest rate of 5.75% and one discount point.

A discount point is one percent of the mortgage loan (i.e. $100,000 X 1% = $1,000). So if you’re willing to pay $1,000 at closing, you will receive a lower interest rate . . . because you are prepaying some of the interest owed on the loan. Generally speaking, the more points, the lower the interest rate, because the mortgage company is receiving some of the interest up front. Needless to say, a lower interest rate means that the monthly payment will be lower.

How to calculate the cost of mortgage points

Example: Interest Rate - 6.00%
Term - 30 Years
Principal & Interest Payment - $599.55
Cost - " 0 "at closing
TOTAL INTEREST PAID OVER THE LIFE OF THE MORTGAGE
$ 115,838.19

Mortgage Point Calculation
One point loan as seen as a pie chart

Example:
Loan Amount - $100,000
Interest Rate - 5.75%
Term - 30 Years
Principal & Interest Payment - $ 583.57
Cost - $1,000 at closing

Two pimt loan as seen as a pie chart

Example:
Loan Amount - $100,000
Interest Rate - 5.50%
Term - 30 Years
Principal & Interest Payment - $ 567.79
Cost - $2,000 at closing

Three point loan as seen as a pie chart

Example:
Loan Amount - $100,000
Interest Rate - 5.25%
Term - 30 Years
Principal & Interest Payment - $ 552.20
Cost - $3,000 at closing

Should I pay points on a mortgage loan?

Example:
Loan Amount - $100,000
Interest Rate - 5.75%
Term - 30 Years
TOTAL INTEREST PAID
$ 110,086.23
Savings - $5,751.96

Example:
Loan Amount - $100,000
Interest Rate - 5.50%
Term - 30 Years
TOTAL INTEREST PAID
$ 104,404.04
Savings - $11,434.15

Example:
Loan Amount - $100,000
Interest Rate - 5.25%
Term - 30 Years
TOTAL INTEREST PAID
$ 98,793.33
Savings - $17,044.86

As you can see, paying points can actually save you money over the life of the mortgage. The decision to pay mortgage points is a decision between you and the mortgage company and a good calculator

Shopping for the lowest interest rate

Be careful when calling around for the "lowest interest rate". Some lenders will give you an unbelievable interest rate, but not tell you that there's discount points associated with the quoted rate, or the interest rate is not guaranteed. Read more

The seller can pay your discount points

The mortgage programs (i.e. FHA, VA, USDA & conventional) permit the seller to pay a percentage of the buyer's closing costs, including discount points (seller assist). Here's how discount points can reduce your monthly mortgage payment even though the mortgage amount is HIGHER! In this example, the home is offered for sale at $103,000. We'll ignore the down payment for simplicity and assume your are able to obtain 100% financing (no down payment mortgage). If the seller is willing to sell you the house for $100,000 and you obtain a no point loan at 5%, your monthly payment for a 30 year fixed rate term is $536.82 (principal and interest). But if you make a full price offer and ask the seller to pay 3 points. The discount points lowers your interest rate and consequently brings down you monthly payment.

Interest Rate 5.00%4.25%
Term3030
Mortgage Amount100,000103,000
Payment536.82506.70

Points can improve your debt to income ratio

Lenders determine the maximum monthly mortgage payment using a formula called debt to income (Read more). Buying points can lower the mortgage payment, which in turn can improve your debt to income ratio.

Lenders can pay your discount points

Mortgage lenders are permitted by the loan programs to buy down your interest rate. Lender paid discount points is an easy way to lower your interest rate, provided you can find a willing lender.





Frequently Asked Questions about mortgage points

Are mortgage points paid up front?

The points are usually paid at closing/settlement for purchase loans. For refinance loans, the points can be financed into the new loan or paid in cash.

Are mortgage points part of closing costs?

Yes

How many points can I buy on a mortgage?

There is no mortgage point limit, however, the impact of mortgage points on the interest rate tends to deteriorate after 3 to four discount points.