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Should I Buy Mortgage Points Up Front?

What you'll learn: Learn about points and pros and cons of paying them upfront.

EXPECTED READ TIME: 6 MINUTES

Should I Buy Mortgage Points Up Front?

 

A lower interest rate on a mortgage can make any homebuyer’s ears perk up. One way to achieve that is through points on a mortgage, but it brings up questions that can cause even the savviest of homebuyers to scratch their heads. What are mortgage points and when should you pay them – if at all? Continue reading and see how to decide.

What are points on a mortgage?

Sometimes lenders offer the option to buy down your mortgage with points. Mortgage points, also called discount points or buy-down points, all mean the same thing: a fee your lender collects in exchange for a lower interest rate.

Though points will increase your initial costs, they can reduce your monthly mortgage payments and save money on the loan in the long run.

Note: You may also hear about “origination” or “lender” points. This is when a lender bundles the fees and charges they incur while processing a loan and passes it on to the borrower as a single cost. Many lenders do not charge origination points. For our purposes, the term “points” refers to mortgage discount points and not origination points.

How are mortgage points calculated?

Each discount point is equal to one percent of the loan amount. On a $225,000 loan, one point would cost $2,250.

While the cost of points is universal, the discount on your interest rate varies. The reduction is based on your lender, the type of loan, and what’s happening in the mortgage market as a whole. Generally, one point can buy a rate down by an eighth to a quarter percent.

Paying points up front vs. financing

Mortgage discount points are traditionally paid up front, but sometimes you have the option to roll them into your loan. In that case, they’re added to your principal and paid off through your monthly mortgage payment.

To see how this change could impact your loan, let’s compare the costs of paying points up front vs. financing points. We used a mortgage points calculator to run the numbers for a $250,000 mortgage with a fixed rate for 30 years. Both options purchased one discount point to secure an interest rate of 5.75 percent.

 

Option 1:

Points Paid Up Front

Option 2:

Points Financed

Closing Costs

$12,500

$10,000

Monthly Payment

$1,459

$1,473

Months to Break Even

48

124

Total Interest Paid

$275,216

$277,968

Net Savings

$11,876

$9,124

As you can see, the closing costs were highest for the up-front payment (Option 1) because it included the $2,500 fee for the discount point. Option 2 absorbed that cost into the loan, which increased the monthly payment by $14 ($1,473 - $1,459) and it increased the total interest paid by $2,752 ($277,968 - $275,216).

Ultimately, we find the most substantial savings comes from the up-front payment (Option 1). There’s still a benefit to financing points (Option 2), but the savings is nearly $3,000 less and it takes more than six years longer to make the rate discount pay off.

Let’s summarize the pros and cons of paying mortgage points up front as part of your closing costs.

Advantages of paying points up front:

  • Reduce your monthly mortgage payment
  • Pay less in interest over the life of the loan
  • Shorter time to break even than if you financed points
  • Sometimes you can negotiate to have points paid by the seller
  • There may be a tax advantage

Disadvantages of paying points up front:

  • Adds thousands of dollars to your closing costs
  • Ties up funds that could’ve been used to pay off other debt or invest for potentially higher gains

Points and different loan types

The opportunity to purchase discount points is pretty widespread across lenders and mortgage types, but you don’t always have a choice about how or when they’re paid. Let’s compare points rules between some of the most common types of mortgages: conventional, FHA, and VA.

 

Discount points available?

Can you finance points?

Can the seller pay points?

Conventional Purchase Loan

Yes

No

Yes

Conventional Refinance

Yes

Yes – as long as you still meet DTI and LTV requirements

N/A

FHA Loans

Yes

Yes

Yes – but not more than 6% of the home cost

VA Loans

Yes

Yes

Yes

Should you buy down your rate?

You’ve seen how points, whether paid up front or financed into the loan, can save you money throughout the life of your loan. Does that mean you should always buy down your rate? Not necessarily.

One of the driving factors will be how long you plan to keep the mortgage. Saving $10,000 or more in interest may sound appealing, but remember, that’s spread across the full term – often 30 years. Is there a chance you’ll move before that? Does the market suggest rates will fall below what you could’ve bought, making a refinance a better option? You’ll want to first make sure you’ll come out ahead if you sell your home or want to refinance before the full term.

To determine if a buy down is worth it, calculate how long it will take to break even on the investment. This is called the break-even point.

To calculate the mortgage points break-even point:

  1. Determine the monthly savings between your potential payments.
  2. Divide the up-front cost to buy the rate by the monthly savings.
  3. Divide by 12 to see the years until you break even.

Here’s an example for a $225,000 loan:

 

6.50%

6.00%

Cost to Buy Rate

$0

$5,000

Monthly Payment

$1,422

$1,349

  1. $1,422 – $1,349 = $73 monthly savings
  2. $5,000 / $73 = 68.5 months
  3. 68.5 / 12 = 5.7 years

In this case, it would take almost six years to start reaping the savings of the lower interest rate. If you plan to sell before that, it would not be worth it.

Keep in mind, this number will change if you choose to finance mortgage points instead of paying up front. A mortgage points calculator can help show the difference.

 

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