Are Mortgage Points Good for the Home Buyer?

Outside of choosing between a fixed- or adjustable-rate loan, deciding whether to pay mortgage points is probably the biggest mortgage decision you'll have to make.

This page:

  • Explains what mortgage points are

  • Distinguishes mortgage discount points from origination points

  • Helps you decide if paying mortgage points benefits you

In the following pages we describe the elements of the mortgage package. The second section of the guide examines your credit capacity and how lenders look at the mortgage collateral.

Refer to the table of contents if you're looking for specific information.

What are points and should you pay them?

Briefly, points are cash paid to the lender at closing time with each point worth 1% of the amount of the mortgage. Paying points can lower the interest rate you pay on your mortgage considerably and potentially save you thousands of dollars.

However, not all points are created equal. There are discount points and then there are origination points.

When we say that points can save you thousands of dollars in interest, we are referring only to discount points.

Origination points are nothing more than lender fees added on at closing, and they do nothing for you. And while they may be unavoidable on a subprime loan, if you qualify for a standard mortgage you should never agree to pay them.

Sidebar
Our top-rated prime lender, Eloan never, ever charges origination points. Apply there first - it won't hurt you to try, and if you do not qualify, FullSpectrum Lending guarantees the lowest sub prime rates and very seldom charges origination points.

So what are discount points?

A discount point is a fee equal to one percent of a mortgage's total value (not your home's value,) paid upfront, at closing. In return for paying this interest early, the lender treats the entire loan as less of a risk, and charges a lower interest rate. In this sense, points are actually prepaid interest on the loan. The number of discount points in a standard mortgage package usually ranges from zero to four and the interest rate is (usually about 1.25 percentage points) lower for each additional point.

Sound like a trade-off? It is. So, you may ask: when should I pay discount points?

It has everything to do with how long you stay in your home. Discount points "pay for themselves" in interest savings eventually, but for every point you need to stay in your home a certain amount of time before you start saving money.

Because points are actually prepaid interest, if you pay a lot of them at closing and then move right away, you essentially are paying interest on a mortgage balance that you never got to use. On the other hand, if you stay in your home for a while, paying points makes sense because your low interest rate ends up saving you a lot of money

To find out if paying points is worthwhile on your loan, decide how many points you'd be willing to pay. For each combination of points and interest rate, calculate how long it would be before the total interest paid equals the amount paid up front in points.

Any amount of time the mortgage is kept past this point saves you money, but if you move before this time, you end up paying interest with no benefit to you.

There are also other considerations: a point is worth one percent of the entire loan amount, which considering the size of most home mortgages, is no small sum. Many home buyers simply won't have that kind of cash available upfront (especially after all the closing costs!)

Paying points can be especially difficult for if you're a first time home buyer, and you may simply have to opt for a higher interest rate on your mortgage.

Even if you do have extra funds available, they may be more usefully put toward increasing the size of the down payment. If your down payment is for less than 20% of your home's value, your lender charges you private mortgage insurance (also known as PMI) and sometimes a higher interest rate as well. If paying points means the difference between a down payment of 20% or a smaller one, you should probably put your cash toward the down payment. There is more information ahead about how your down payment and discount point relate.

The tax considerations of paying points

Points, because they are actually interest payments, are usually tax-deductible. In most cases, the entire deduction has to be taken the first year (when the points are paid) rather than spread over the life of the loan. (This is not always the case when refinancing.)

This is usually a good thing, because it makes your first year easier when you already are paying so much in other home-related costs.

However, depending on your income level, spreading the interest over the life of the mortgage may make more tax sense. If you're on the edge of a tax bracket, and paying interest every year puts you in the lower bracket, you may not want to pay points even if they make sense in other ways.

In conclusion, the time you plan to spend in your home should be your number one concern when you decide whether or not to pay points on your mortgage. They can either be a great source of savings or a useless tying-up of cash that you'd be free to spend elsewhere otherwise.



Next: Your biggest one-time expense, the down payment

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