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Mortgage Basics

How Do Mortgage Points Work?

Mortgage points work by essentially letting you buy a lower interest rate. It's not always a good idea, but if you're settling down and don't expect to refinance your mortgage soon, purchasing mortgage points could be wise.

What Are Mortgage Points?

There are two types of mortgage points:

  • Origination points are part of the many fees you may pay a mortgage lender. This type of mortgage point doesn't affect you beyond being a cost associated with getting your loan. Understanding origination points may help you comparison shop lenders to find one with the lowest fee and negotiate the fee amount.
  • Discount points are points you can buy to lower the interest rate on your mortgage. Discount points are a form of prepaid interest, so buying points when you first take out your loan can lower your monthly payment and overall cost of borrowing. Each discount point costs 1% of your loan amount.

For our purposes, let's focus on discount points.

What Are the Benefits of Mortgage Points?

The main benefit of buying mortgage points is reducing your loan's interest rate and thus the amount you'll pay over the life of the loan. Generally, each point lowers your interest rate by 0.25%, although the exact amount can vary.

Lowering your mortgage interest rate can decrease your monthly payments, making it easier to manage your budget. Additionally, the cost of the points could be an itemizable tax deduction because you're prepaying mortgage interest. If you meet IRS requirements, you could take the entire deduction during the year you paid the points. Otherwise, you may be able to claim the deduction over the lifetime of your loan.

How to Calculate Mortgage Points

Before you buy mortgage points, calculate the break-even point—when your savings from receiving a lower interest rate equal the cost of the points.

For example, if you're looking at a $300,000 mortgage, each point will cost $3,000. Say the mortgage has a fixed-rate, 30-year term and 4.5% interest rate, and the point you buy lowers the interest rate to 4.25%.

As a result of buying the point, your monthly payment will decrease from $1,520 to $1,476, a savings of $44 per month. Divide the $3,000 by $44 and you'll find it takes 68 months (or 5.7 years) to break even.

If you think you may move or refinance before 68 months, buying mortgage points won't have much of a benefit. But if you expect to be making the mortgage payments past your break-even point, mortgage points could save you money.

Fortunately, you can search online and find calculators that can do the math for you. The hard part may be deciding how long you're going to stay in the home.

Should I Buy Mortgage Points?

Mortgage points may not be right for every homebuyer. Figuring out the break-even point is a good start, but there's more to consider before buying points. For example, you'll need to come up with the money to pay for the points.

Although a point generally lowers your interest rate by 0.25%, the reduction per point can vary depending on the lender, type of loan and market conditions. Make sure to run the numbers that apply to the specific mortgage you're considering.

Even when you plan to pay for points, you should still get competing mortgage offers to see which rate and terms are best. Paying for points from one lender could decrease your rate, for example, but it could still end up higher than a competitor's offer.

You may find that the value of each point from the same lender changes as you compare types of loans. Additionally, if you're considering an adjustable rate mortgage, look to see if the lender will continue to apply the interest rate reduction after your initial fixed-rate period ends.

All that said, the simplest and easiest solution may be to simply put money toward a bigger down payment.

How a Good Credit Score Can Lower Your Interest Rate

Buying mortgage points isn't the only thing that can impact your loan's interest rate. You may get offered different rates depending on the lender, type of loan and how much money you put down. Additionally, your credit can have a direct impact on your mortgage rate.

For example, using the FICO Loan Savings Calculator, you can see how increasing your FICO® Score* can lead to lower interest rates. For a $300,000, 30-year fixed-rate mortgage, the national average rate is currently 4.378% for those with a FICO® Score in the 640 to 659 range. This translates to a monthly payment of $1,498.

However, increasing your credit scores to the 680 to 699 range would bring your rate down to 3.734% and monthly payment down to $1,387. To buy the same rate change, you'd have to purchase 2.576 mortgage points at a cost of $7,968.

Learn more about improving your credit, and ideally start working on your credit long before you buy a home.

Mortgage Points Are Only Part of the Calculations

While purchasing mortgage points can lower your interest rate and may save you money, keep the big picture in mind as you plan your purchase. If you have time, improving your credit and saving up for a larger down payment can be important steps that could save you even more. Then, shop around and compare offers to find the loan that will cost you the least overall.

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