What first-time buyers need to know about mortgage points

Purchasing a home is the most costly and complicated transaction you’ll likely ever experience. As interest rates rise, buying discount points on a mortgage can be an attractive option to get a lower interest rate.

Buying down your interest rate now can potentially save you more over the life of your loan, but it’ll cost you more up front. Here’s how to weigh the difference and determine if buying discount mortgage points is a good choice for your situation.

• What are mortgage points?
• How do discount points work?
• How much does one discount point lower your interest rate?
• Pros and cons of mortgage points
• Should you buy mortgage points?

What are mortgage points?

Mortgage points — also called discount points and mortgage discount points — are something you can buy during the lending process that’ll lower your interest rate. They can be part of your closing costs, or you may be able to roll them into your mortgage or get the seller to pay for them.

How do discount points work?

Discount points are essentially an upfront fee you pay to a lender for it to lower your interest rate. The fee compensates the lender for the lowered interest payments you’ll be making later.

If you’re a first-time homebuyer shopping for a mortgage, or you’re a homeowner looking to refinance, you may find that lenders have wildly different advertised rates. That’s because lenders with suspiciously low rates may be including discount points in their advertised interest rates.

For the best apples-to-apples comparison when shopping for a mortgage, compare the annual percentage rate (APR). The APR is a more accurate representation of what a loan will cost you. It reflects the interest rate, discount points, mortgage broker fees, and other charges you pay to get the loan.

How much does one discount point lower your interest rate?

Each mortgage point costs 1% of the total loan amount and typically lowers your interest rate by around 0.25%. It’s also possible to buy fractional points at a proportional cost.

For a loan of $200,000, for example, one point would cost $2,000 and 2.5 points would cost $5,000.

To see how discount points can affect interest rates, closing costs, and monthly payments, consider the example below, which shows the impact of having a different number of points on a 30-year fixed-rate mortgage worth $200,000 with an initial interest rate of 7.25%:

• 7.25% with 0 points — $1,500 closing costs and a $1,364 monthly payment
• 7.00% with 1 point — $3,500 closing costs and a $1,331 monthly payment
• 6.75% with 2 points — $5,500 closing costs and a $1,297 monthly payment
• 6.50% with 3 points — $7,500 closing costs and a $1,264 monthly payment

WHAT CREDIT SCORE DO YOU NEED FOR A MORTGAGE?

Pros and cons of mortgage points

Mortgage points can potentially save you thousands of dollars in interest over the life of your loan. As long as you can afford to purchase them and will have your mortgage long enough to break even on the costs, they’re an option you should consider.

Here some pros and cons of purchasing mortgage points:

Pros

• Lowers your interest rate
• Reduces total interest costs over the life of your loan
• Can be tax-deductible

Cons

• Increases closing costs
• Ties up money you could have used for your down payment
• Can take years to break even on the cost

HOW TO GET PRE-APPROVED FOR A MORTGAGE (AND WHY IT’S A MUST RIGHT NOW)

Should you buy mortgage points?

Buying mortgage points depends on your situation and preferences. You’ll need to consider if you can afford to buy the points and still put 20% down, and if you’ll keep the mortgage long enough to break even on the closing costs.

Buying mortgage points makes sense if:

• Your seller is paying for them.
• You have enough cash that you can buy them and still put at least 20% down.
• You plan to stay in your home for a long time and don’t think you’ll want to refinance if rates go down.

Buying mortgage points doesn’t make sense if:

• Doing so means you can’t put 20% down. Putting less than 20% down means you’ll have to pay private mortgage insurance (PMI), and you may not qualify for the best interest rate.
• You think you’ll refinance or sell your house before your break-even point.