At a glance: This article answers two common questions among home buyers and homeowners. How much does a mortgage point cost, for the borrower? And how much can I save over the long term by paying points?
What Is a Mortgage Point, Exactly?
When researching home loans, you’ve probably encountered the term “mortgage point.” In fact, that’s probably what brought you to our website.
But what are they, exactly? Why do some borrowers choose to “pay points” at closing? How does it all work?
Let’s start with a basic definition:
A mortgage point is a type of fee paid directly to the lender, in exchange for a lower interest rate. Numerically, one point is equal to one percent of the loan amount.
Some borrowers choose to pay mortgage points in exchange for a lower interest rate, with the end-goal of saving money over the long term. You’re basically paying some interest up front, at closing, in exchange for a lower rate over the life of the loan.
You don’t have to pay points when taking out a mortgage loan. It’s optional. In some cases, it works out to the borrower’s advantage. Other times not. It largely depends on how long you end up keeping the loan, as we’ll discuss below.
How Much Does a Mortgage Point Cost?
On to the next question: How much does it cost to buy a mortgage point from a lender, when buying or refinancing a home?
As mentioned above, one mortgage point is equal to one percent of the loan amount. Another way to think of it is that one point equals $1,000 for every $100,000 of the loan amount being borrowed.
- One point on a $400,000 mortgage loan would cost $4,000.
- One point on a $300,000 mortgage loan would cost $3,000.
- And so on…
To calculate the cost in your situation, you would simply multiply the loan amount by 0.1 (the decimal form of 1%). In the first example above, the math would look like this: 400,000 x .01 = 4,000.
It’s also possible to pay half a mortgage point, one and half, etc. Half a point is equal to half a percent of the amount being borrowed. The decimal form of a half percent is .005.
Example: If I want to know how much half a mortgage point would cost on a $600,000 loan, the math would look like this: (600,000 x .005 = 3,000).
There are many ways to slice it, but the basic math is always the same.
How Much Will It Lower My Interest Rate?
We’ve covered part of the math above, by explaining how much a point costs when taking out a home loan. It’s equal to one percent of the amount being borrowed — always.
Let’s move on to another common question among borrowers: How much does a point save you on your mortgage loan? This question is a bit more complicated, because it can vary from one mortgage lender to the next.
Usually, one point will lower the borrower’s mortgage rate by 0.25%. But this can vary. So be sure to ask your lender exactly how much they’ll be discounting your interest rate, under different point scenarios.
We used the word “discounting” above. That’s exactly what is happening here. The lender basically discounts the rate by charging you a certain fee at closing. For this reason, they’re also referred to as “discount points.”
What Will I End Up Saving?
Last question: How much can you, as a borrower, save by using mortgage discount points? This will depend on several factors. (You might have noticed, the questions in this article have gone from simple to complex.)
To answer this question, you need to know how much the lender is discounting the rate, and what your monthly payments would be with and without the discount.
Ideally, you want to do a side-by-side analysis that compares:
- Your monthly payments with discount points paid.
- Your monthly payments without using any mortgage points.
Based on this, you can calculate your monthly savings. You would simply subtract the larger monthly payment amount (#2) from the smaller amount (#1). That shows you how much you’re saving each month, by using the points to secure a lower interest rate.
But this only shows you part of the picture. You also want to know when you’re going to reach the “break-even point.”
Calculating the Break-Even Point
The break-even point is the point where the money you save (from refinancing into a lower interest rate) begins to surpass the amount you paid in closing costs.
Example: If I’m going to end up paying $9,000 in closing costs to refinance my home, I want to know how long it will take to reach $9,000 in savings. That’s a key piece of information.
The break-even can help you determine if refinancing makes sense:
- If you think you might move before reaching the break-even point, then it probably doesn’t make sense to refinance. In that kind of “short-stay” scenario, you might end up paying more in closing costs than what you saved with a lower monthly payments.
- If you think you’ll be in the home and keep the new loan long after the break-even point, then refinancing should work out to your advantage.
Here’s a graphic, created by Bank of America, that shows how to calculate your break-even point:
So there you have it, an overview of mortgage points and how they work. We hope you have found this article useful. If you’d like to read more content like this, be sure to check out the articles page on this website.
Disclaimer: This article answers the interrelated questions: How much does a mortgage point cost, and how much will it save me? This article includes general statements and scenarios that might not apply to your unique situation. The only way to find out if you could benefit from refinancing is to speak to a lender and do the math for yourself.