Mortgage points, also referred to as ‘discount points,’ are payable at closing. Each point is charged at 1% of your mortgage loan and reduces your interest rate by a certain amount. The amount by which the rate is reduced for each point varies according to your mortgage and your lender, though an average is 0.25% – 0.5%. However, 0.125% and 0.75% have also been offered.
Because your interest rate is reduced, your monthly repayment will also be reduced. This does not affect how long it takes to clear your mortgage, since the mortgage terms remains the same – you just pay less interest each month because your interest rate is less. Lenders will also place a limit on the number of discount or mortgage points you can purchase.
Why Pay Mortgage Points
On every $100,000 of your mortgage, one point will cost you $1,000 which must be paid at closing. What can you save by doing this? If your mortgage was $200,000, you would pay $4,000 for two mortgage points at 0.25% each, saving you 0.5% interest rate. You can work out how much this can save you using an amortization calculator.
We shall consider your monthly payment and your total interest paid for the term of the above mortgage over 30 years and 15 years. If you had the above $200,000 mortgage over 30 years, two points totaling 0.5% would save you $56.74 each month. You total interest savings over the 30 years would be $20,426.83.
Over 15 years the corresponding saving would be $49.61/month and $8,929.94. Points therefore save more the longer the term of your mortgage. Over 30 years, your initial $4,000 would be repaid within 5 years 10 months, and over 15 years in 6 years 9 months. The longer the term of your mortgage the quicker the payback, and the more you save overall.
General Aspects of Paying Points
• Keep in mind that the above rate reductions per point are examples only. The actual rates offered can be more or less than this. 0.25%, however, is a good average.
• If you have an adjustable rate mortgage, your points will apply only to the initial fixed rate. Points are therefore not usually purchased with ARMs.
• You might be able to claim a tax benefit on points: check up with your tax adviser on this.
Something else you must consider is that if you make a down payment of 20% of the purchase price, you can avoid paying Private Mortgage Insurance. You should be careful how you spend your spare cash: if buying points prevents you making a 20% deposit, then do the math. Compare the price of PMI each year with what you would save with your points each year.
Mortgage points can be a good investment for you. However, they tend to be more viable with longer term mortgages. You are advised to check the cost of points with your mortgage, how much each point is worth, and then calculate the benefit to you of buying points. They work for many people, but not for all.