Mortgage points are often part of your loan package. Paying for these points can help you lower your interest rate. However, you will need to determine whether paying for points makes sense for you. In order to make that decision, you’ll want to understand a little more about what mortgage points are.
A mortgage point is nothing more than a fee that is equal to one percent of your loan amount. Lenders often charge points on a loan, or fractions of points, when advertising their rates. This means that when you hear about a lender offering a particular interest rate, you also need to look at the number of points you will pay to get that rate.
Calculating mortgage points is easy. The formula is:
Loan Amount x .01 = Point amount
For example, if you were getting a loan for $200,000, your point amount would be $200,000 x .01 or $2,000.
There are two different types of points. One is a discount point and the other is origination points.
Discount points can help you reduce your interest rate by being willing to pay money up front. The more points you pay, the lower your interest rate. Those not paying points will have an increased rate. For each point you pay, your interest rate is typically reduced by 0.25%. So, if the going rate for a mortgage is 5%, by paying for two mortgage points, you could reduce the rate to 4.5%.
Origination points are charges the lender requires in order to create your loan. Not all lenders use origination points. These points are often negotiable.
You may be wondering if it is worth it to pay money up front in order to save money over the course of your loan. You may also be wondering how many points you should pay? The answer is this: it depends.
The longer you plan to live in your home, the better it is for you to take discount points. That’s because the longer you live in a home, the more interest you pay. Reducing your interest by 0.75% on a $125,000 loan can save you close to $675 a year. Over the course of a 30-year mortgage, this adds up to far more than the $3750 you paid for the three points. On the other hand, if you don’t have enough cash-on-hand to pay the points, then it is better to take the higher interest rate.
Figuring out the right number of points to pay versus the interest rate is something that is different for each individual. You will have to look at your savings, how much money you want in reserve after the closing, the length of your loan, and how long you plan on staying in the home.
You should also consider what else you could do with the money you plan to spend on points. In the example above, $3750 for points could also be used for new appliances or furniture, savings, retirement, college funds for children, or investments.
Talk to a financial advisor about the best combination for you. Keep in mind that your answer will not be the same as someone else’s, so talking with a professional is a better option than talking with a friend or family member. If you have questions about mortgage points and how they work, give us a call. We’ll tell you what we know and can hook you up with a professional advisor.