Should I Pay Mortgage Discount Points?
Understanding The Basics
Should You Buy Discount Points?
Unsure if you should buy discount points on your mortgage? Use this calculator to compare the full cost of a loan with discount points to one without them. Generally speaking, points are not a great deal if you plan to sell the home soon, but if you plan to live on the home for many years or perhaps throughout the duration of the loan buying points can save you money.
How do Discount Points Work?
>For fixed rate loans points typically lower the interest rate on the loan by a quarter of a percent. Each point costs 1% of the amount borrowed. On a $260,000 fixed-rate home loan buying 2 points would lower the interest rate about a half of a percent & would cost the buyer $5,200. Adjustable-rate mortgages also offer points, but they only lower the interest cost during the introductory rate period.
Can I Finance Discount Points?
Points can be financed in the loan, but doing so increases the amount of time needed to break even, thus if you are buying points it typically makes sense to pay for them upfront.
Can I Use Negative Points?
Some lenders also offer negative points which are an upfront cash payment (usually used to help cover closing costs) coupled with a higher interest rate on the loan. Loans advertised as having no closing costs typically come with negative points.
Are you shopping for a home loan? Today's Ashburn mortgage rates with points are shown beneath the calculator.
Should You Buy Points?
Should you buy 2 points to lower your interest rate from 4.5% to 4.0% on your $260,000 30-year home loan?
It looks like you'll save money buying points if you live in the house at least 68 months. 68 months is the breakeven point where the interest and payment savings exceed your closing costs.
|With Discount Points
$104.65Monthly Payment Savings
50 monthsDiscount Points Breakeven
Current Ashburn Mortgage Rates For $260,000 Home Loans With Discount Points Included
The following table highlights current Ashburn mortgage rates. By default 30-year purchase loans are displayed. Clicking on the refinance button switches loans to refinance. Other loan adjustment options including price, down payment, home location, credit score, term & ARM options are available for selection in the filters area at the top of the table.
Understanding How Mortgage Points Work
When it comes to homebuying, one aspect you should understand carefully are mortgage points. Purchasing mortgage points and whether you pay for them upfront impacts the overall cost of your mortgage. Points should be considered during closing, as well as overtime while you’re making monthly payments.
Note that in some closing deals, points are not an option but a requirement of the buyer. In other cases, the buyer has the option to choose from different APRs based on the addition of points prepaid to the lender. This article will focus on the latter.
What are Mortgage Points?
Lenders offer points which borrowers can use to alter their mortgage rate. Purchasing a discount point, for instance, helps make the cost of your mortgage more affordable. Generally, there are three types of points:
- Discount points – These are purchased by borrowers to lower their interest rates.
- Origination points – These are equivalent to mortgage processing fees rolled into one payment.
- Negative points – These lower your closing costs but add to your interest rate.
Discount points are upfront fees paid to a lender to lower your loan’s interest rate. Some lenders use this term to include any fees involved in closing. But generally, discount points refer to a specific percentage the buyer will pay the lender to lower the interest rate applied to the loan. If you need a more affordable interest rate, purchasing a discount point lowers your APR at the time of origination. That’s how purchasing points can decrease your mortgage’s overall cost.
The other type of point used to cover loan costs is commonly called the origination point. While discount points are an option for the borrower, origination points are typically a requirement. Origination points are paid to the lender to review and process your mortgage. Though it’s required, you can certainly negotiate the cost to reduce your origination fees. Origination points usually cost around 1% of the loan amount. If your lender charges 1.5 origination points for a loan worth $200,000, expect to pay $3,000.
Lastly, negative points are rebates paid by lenders to borrowers or brokers to help them afford closing costs. As a trade-off, it increases the loan’s interest rate. Negative points will be further discussed later in the article.
Discount Points for Fixed-Rate Mortgages
One percent of the loan amount is equal to one whole point. You can purchase parts of a point, such as a half point, a quarter point, or even a point and a half. For example, 1 point on a $300,000 loan is equivalent to $3,000. A half point (0.5 points) is equal to $1,500, and a quarter point (0.25 points) is equal to $750. Given this example, if you want to purchase a point and a half, you must pay $4,500 upfront to your lender. If your original rate is 5% APR, this lowers your rate to 3.5% APR.
Again, paying discount points to a lender decreases your interest rate compared to a zero-point loan of the same type. A lender may structure your $300,000, 30-year fixed-rate loan with choices including paying zero points, paying 1 point, or paying 2 or more points at closing.
Typically, you can get an APR reduction of 0.25% per point on fixed-rate mortgages. But note that it usually varies per lender and offer. The deals offered should reflect an interest rate on the loan that decreases with each additional point (or fraction of a point) that’s been prepaid. How discount points impact APR depends on the loan amount, type of mortgage, as well as the length of the term.
Discount Points for Adjustable-Rate Mortgages
For adjustable-rate mortgages (ARM), a discount point typically reduces interest rates by 0.375% per point. But again, this is just an estimate and it varies per lender. The discount point also corresponds to the fixed-rate period of the ARM. For example, with 5/1 ARM, expect to see a reduced rate for the first 5 years of the loan during the fixed-rate introductory phase. Likewise, for a 10/1 ARM, your interest rate will be decreased for the first 10 years of the mortgage.
Some ARM lenders may also allow you to apply points to reduce the margin. The margin is basically the amount added to the rate index which determines your adjusted rate. This means you could reduce the interest rate for much longer than the introductory period. For example, a margin reduction on a 30-year 7/1 ARM affects the interest rate on the remaining 23 years of the loan, while a rate adjustment would apply to just the first seven years of the same loan.
Make Sure to Compare Options
Lenders’ offers on discount points vary, sometimes to a great extent. A point or two on one deal is not necessarily equal to a zero-point loan for the same amount with a different lender. Arm yourself with research into interest rates, market conditions, federal interest rate trends, and other information that enables you to better see the short and long-term effects of your decision. As with all financial decisions, it is best to consult with a trusted and qualified professional for help.
If comparing loans from multiple lenders becomes confusing, a way to simplify the search is to sort primarily by points or by rate. Then, when you get what you are looking for (say a good rate with 1 point), compare the best offers from other lenders at that same number of points.
How Points Benefit Lenders
Points have an obvious financial benefit to the lender. They receive a lump sum payment upfront for interest that would otherwise trickle-in over time. For this reason, you can think of points offered as a reflection of the overall strength of current market conditions.
When the housing market is strong, lenders may be less willing to extend reduced interest rates. On the other hand, a softer trend might inspire them to try more competitive pricing on their offers. If interest rates are high or the buying market is sluggish, points can help lenders open the field to more qualified homebuyers.
How Points are Advantageous to Borrowers
Most financial experts suggest that you should consider purchasing discount points if you meet the following conditions:
- You have cash-on-hand to pay for the points as opposed to financing them. This is in addition to all other associated closing costs.
- You intend to live long-term in the home, as opposed to moving and selling it after just a couple of years.
- You will live in the house beyond the break-even point. Once you break-even, this is time when your points investment starts to pay back.
Discount points can be tax deductible in the year they are purchased. A borrower also benefits from purchasing discount points by lowering their applied interest rate over time. Though the interest rate typically drops only a fraction of a percentage per point, this difference can be felt in each monthly payment, as well as the total amount you eventually pay.
For example, a $200,000 loan at 5% for 30 years results in a monthly payment of $1,073.64. If the lender offered you 2 points to get 4.75% instead, your monthly payment will decrease to $1,043.29 – saving you $30.35 a month, or $364.20 a year. However, to determine if such a deal is truly worth it, you must calculate the break-even timing.
30-Year Fixed-Rate Mortgage
Loan Amount: $200,000
|With Discount Points (2 Points)
Calculating the Break-Even Point
To understand the value of discount points and its impact on your mortgage, you must figure out how many months it will take to recoup your investment. This is known as your break-even point.
To determine this, you must divide the cost of your points by the monthly savings. This will tell you the number of months it will take to see the full return of investment on your discount points. Here’s the basic formula below:
Break-even point (BEP) = $ Cost of points / $ Amount in monthly savings
Using our previous example above, let’s see how long it will take to break-even on your investment. In the example, each point would cost $2,000 (because 1% of 200,000 is equal to 2,000). To purchase 2 points, this would cost $4,000.
BEP = 4,000 / 30.35
= 132 (rounded to the nearest whole number)
When we divide $4,000 (cost of 2 points) by $30.35 (monthly savings), it results in 132. Thus, it will take 132 months to reach your break-even point on your investment. To estimate your break-even point more easily, you can use the above calculator.
Based on the result, as a borrower, getting this deal does not serve your best interest. Though it’s tempting to obtain 0.25% less on your APR and save $30.35 a month, it would take you 132 months or 11 years to recoup the full $4,000 investment. It shows that purchasing two points is too much just to get a 0.25% rate reduction.
However, if you negotiate for one point instead of two, this will decrease your investment and closing cost. It will also reduce the time it takes to reach your break-even point. Since one point is equal to $2,000, if we divide this by $30.35 (monthly savings), it will result in only 66 months. This is a much better deal, because you’ll recoup your investment in only 5 years and half.
BEP = 2,000 / 30.35
On the other hand, you might also encounter a more favorable reduction rate. For example, a lender might offer 4.55% for two points instead. This results in a monthly payment of $1,019.32, which saves you $54.32 per month.
30-Year Fixed-Rate Mortgage
Loan Amount: $200,000
|With Discount Points (2 Points)
Now, to calculate the break-event point, let’s divide $4,000 by $54.32. The result will be 74, which means it will take 74 months to recoup the cost on your investment.
BEP = 4,000 / 4.32
In this example, 74 months or 6 years is a much better deal compared to the initial offer, which takes 11 years to earn back. And for this offer, it took a change of less than half of one percent APR – the negotiation of one point – to get there.
Another calculation which will help you determine the best course of action is to think about the amount of pure interest paid on top of the principal loan amount. Using the following example, let’s assume each loan ran a full 30 years to maturity. The chart below shows the total interest cost which corresponds to each rate.
30-Year Fixed-Rate Mortgage
Loan Amount: $200,000
|Total Interest Cost
This table above used the simple mortgage calculator to determine the total interest costs.
Based on the table, the mortgage with the lowest interest rate (4.55%) can save you $19,555 over the life of the loan compared to a 5% rate. That’s almost $20k worth of savings, making the two points or $4,000 to get there a shrewd investment, if possible.
Can Points Be Financed?
The short answer is yes, the costs for points can typically be rolled into the financed costs of a loan. However, doing this will create additional time. You must also weigh in on several financial considerations.
First, financing the points will add to your loan balance and the amount of interest paid. You will have an additional break-even point to factor in as well, when the cost of the financed points is repaid in full and the benefit of the reduced rate is reached. A shorter break-even period indicates that the financing could be a shrewd move, where longer periods could change your mind about the value of this effort.
It also assumes the additional costs of financing points do not make the loan exceed the maximum allowed for purchase by Freddie Mac and Fannie Mae. Most experts will agree that if a raised loan insurance premium or increased interest rate results from financing the points, it is probably a deal to think twice about and likely pass by.
Paying cash for the points is almost always going to be a smarter move for the borrower, though it is not always possible. Financing all or some of that cost is certainly an option which is worth a full evaluation.
How Negative Points Work
Negative points are also called rebate points, lender credits, or yield spread premiums. This basically works in reverse. While discount points lower your home loan’s interest rate, negative points are offered by lenders to incrementally increase your loan's interest rate. In exchange, you receive a discount on your closing cost.
In the same way one discount point is roughly equal to a 0.25% APR reduction, a negative point will add this difference in exchange for one percent of the loan’s value. It’s applied as a borrower credit to closing costs. Note that you cannot use negative points toward any part of your down payment or cash them out.
To give an example, let’s say you’re negotiating your $200,000 loan and your lender offered a deal structured with 1.5 negative points. This changes the rate from 5% to 5.4% APR. If you take this negative point, you obtain $3,000 toward your closing costs.
When to Take Negative Points
Negative points make more sense when you have less cash reserves available to close a deal. A slightly higher monthly premium is also reasonable. Taking negative points may be a smart move for people who are looking to take deal for a short period of time. These include home flippers, people who will eventually move, or landlords who are not concerned about the higher monthly mortgage payment over time.
On the other hand, negative points make less sense when you are planning to hold on to the property for a long time. This will increase your monthly premiums for the duration of the loan, and you’ll end up paying more.
Beware When You Take Negative Points
Unfortunately, brokers are not always forthcoming about the availability of rebates or negative point loans. They may see it as an opportunity to collect more cash from a sale. To stay abreast of reasonable rates and parameters, rely on help from your own agent and keep yourself updated about current rates and trends.
Negative points can be used by brokers to package what they call “no-cost mortgages.” This, of course, is far from the truth. In reality, the broker often uses negative points to earn more from the deal. The hidden cost is actually an increased interest rate, undisclosed to the buyer.
Using our example, a $200,000 loan might be offered at 5.8% with zero points at closing. However, that would likely seem a bit high to you. If the current market rate is closer to 5%, zero points to close certainly sounds attractive. The same lender offers you 5.5% for one point or 5.25% for two points at closing.
The broker may be using negative points to reach their 5.8% “no-cost” offer, using the rebate it produces to pay down associated costs. The idea of a no-cost mortgage is misleading, as you will be paying a higher interest rate over the life of the loan. Though there is no upfront cost, you will definitely feel the financial impact when you pay your mortgage for the rest of the term.
In all three examples, the broker would not lose money – even on the no-cost offer. Brokers can offer these kinds of deals, obtaining their own needed return from the rebate of negative points. They can do this successfully, especially if they never tell you that the rebate is happening behind the scenes.
Finding the Best Deal
Today’s homebuyers have a plethora of mortgage options to sort and understand. Note that each lender will be different, and they will likely offer you multiple deals to consider. How you choose the right mortgage deal is determined by these common factors:
- Time: How long do you intend to own the property? Short-term plans are often bolstered by negative points, and potentially financing options. However, if you intend to keep your property for a long time, paying cash for discount points will help. Likewise, financing negative points would be costly.
- Cash: If you can pay for your discount points at closing, it has a direct and compounding impact to your loan’s value over time. This does not negate financing options. But rolling the costs of points into the loan is not as desirable as having cash to pay for them upfront. Your cash flow should guide you, both on-hand and to cover monthly premiums.
- Break-even: Will you have a decent break-even point to recoup your investment? If a benefit is countered by too much time to break even, it may be less valuable or not worth the investment. You can use our calculator on top to determine the break-event point on a prospective investment.
Taken together, these three factors should help guide you in choosing the best deal that suits your budget.
The following table compares loans with discount points and negative points. Refer to this example to help you understand the basics of how different points affects the overall cost of a mortgage.
30-Year Fixed-Rate Mortgage
Loan Amount: $200,000
|# Months to Break-even
|Total Interest Paid
When you take out a mortgage, you can take points to adjust your mortgage rate. One percent of a loan is equivalent to 1 point. There are three main types of points you should consider before closing a mortgage deal. These are discount points, origination points, and negative points.
Discount points are purchased by borrowers to decrease their home loan’s interest rate. This can be purchased in parts, such as a half, a quarter, a third, etc. However, lenders offers on discount points can vary greatly, so be sure to shop around and compare your options. This will help you secure the best deal.
How discount points affect your rate depends on the type of loan, the size of your loan amount, and the length of your term. Discount points are ideal if you have cash on-hand to pay for the points, and if you intend to stay long-term in a house. Ideally, you should stay long enough to reach the break-even point, which is when you recoup the cost of your investment.
Next, origination points are fees you pay to your borrower to assess and process your mortgage. It typically costs around 1 percent of your loan amount. This is negotiable, and it pays to convince your lender to slightly reduce your origination fees to lower your closing costs.
Finally, negative points are used by borrowers to reduce their closing costs. But as a trade-off, this increases the loan’s interest rate. Negative points are ideal for people who will not stay long-term in a house. If you’re sure to move in a few years, this will benefit you. It’s taken by consumers who do not have to worry about the high cost of future mortgage payments.
Apart from understanding how points work, keep yourself informed. Gather more information from trusted sites like Fannie Mae on their sponsored Know Your Options site, or in Freddie Mac’s Research Center. Government resources such as the CFPB can also help, as well as the mortgage calculators offered on this site.
Ultimately, whether or not you choose points and how they are paid, depends entirely on the particulars of your deal and situation. But knowing how they work will put you in a better position to make a wise, balanced, and safe choice for your finances.
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