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What Are Mortgage Points and When Should I Buy One?

by Brandon Cornett

Understanding the terminology associated with home buying and mortgage loans will go a long way toward ensuring a smooth home-buying experiece. Mortgage points are a good example of this need to understand terminology, because they directly affect your loan payments each month. So what are mortgage points and what do they have to do with applying for a home loan? That's what we will discuss in this article.

Definition: A mortgage point (a.k.a. discount point or mortgage loan point) equals one percent of a loan amount. For instance, on a loan of $200,000, one point would equal $2,000.

Why Pay for Mortgage Points?

Some home buyers pay mortgage loan points to their lender during settlement. They do this to lower their interest rate over the life of the loan. Paying a point on a 30-year home loan will generally lower the interest rate by .125 percent.

Should I Pay for Points?

Buying points can lower the interest rate of a mortgage loan, but that doesn't automatically make it a good idea for every home buying scenario. For example, if you'll only live in the home for a couple of years, paying for points probably won't help you.

On the other hand, if you plan to live in the home — and keep the loan — for a long time, paying for mortgage points might very well save you money.

To find out whether or not points will benefit you, you'll need to determine your "break even" point. In other words, you need to do figure out how many months you'll have to live in the home to make mortgage points a wise investment.

To calculate your "break even" point:

1. Determine your monthly payment without buying points.

2. Determine your monthly payment if you did buy a point (or points).

3. Subtract the lower payment from the higher payment to determine your monthly savings.

4. Divide the amount charged for points at closing by the amount you save each month. The number you end up with equals the number of months you must keep the mortgage to reach your "break even" point.

Example calculation:

Let's do a sample calculation for a $200,000 mortgage loan for 30 years at a fixed rate.

1. 7% interest rate with no points = $1,330.60 monthly payment

2. Buying 1 point for $2,000 = $1,313.86 monthly payment

3. Monthly savings after the point: $16.74

4. $2,000 / $16.74 = 119 months

In the example above, the "break even" point is 119 months, or about 10 years. You would have to keep the home (and the mortgage) for 10 years to regain the cost of the point you paid at closing. If you plan to stay in the house for only three or four years, paying for points would be a bad investment.

Conclusion

A mortgage point equals one percent of your loan amount. You can pay points to your lender at closing to lower your interest rate. Paying points may be a wise option if you plan on living in the home for more than a few years. You should always run the numbers to find out if points are a good investment for you.

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Brandon Cornett is the editor of HomeBuyingInstitute.com