Mortgage Points: What They Are and How They Can Benefit Homebuyers

Buying a house is often the largest investment most people will ever make, and it's natural for potential homeowners to explore strategies to minimize the cost of their mortgage. Sure, securing a good purchase price and shopping around for the best mortgage rates are two fundamental strategies. However, there's another strategy that some buyers may not be familiar with, but that can potentially offer considerable financial benefits - purchasing mortgage points.

Understanding Mortgage Points

Often referred to as "discount points," mortgage points serve as a mechanism for homebuyers to lower their mortgage interest rate. But how does it work?

Essentially, mortgage points are fees paid directly to the mortgage lender by the borrower. These fees are used to lower the interest rate on the mortgage loan, decreasing the total amount of interest the borrower pays over the life of the loan. This strategy is sometimes known as "buying down the rate."

Cost and Benefits of Mortgage Points

Typically, each mortgage point costs 1% of the mortgage amount. This means that one point on a $300,000 mortgage would cost the borrower $3,000. The purchase of these points effectively translates to prepaid interest. By purchasing mortgage points, the loan's interest rate is lowered, usually by 0.25% per point. Depending on the lender, borrowers may have the flexibility to buy a fraction of a point, or up to three whole points, or sometimes even more.

By using mortgage points to reduce your loan's interest rate, you can also lower your monthly payment. However, it's important to remember that purchasing points requires an upfront payment. Therefore, the more time you plan to spend in your new home, the more benefit you'll reap from buying points.

Discount Points vs. Origination Points

It's crucial to distinguish between mortgage points that reduce your interest rate, known as "discount points," and another type of point known as "origination points."

Origination points don’t influence the interest rate on your loan, but instead are mandatory fees charged by lenders to originate, review, and process your loan. Like discount points, one origination point equates to 1% of the total mortgage amount. So, if a lender charges 1.5 origination points on a $250,000 mortgage, the borrower is required to pay $3,750. These origination points are generally paid as part of your closing costs when you finalize your home purchase.

Not all lenders charge origination points on their mortgages. Some lenders offer loans with no or reduced closing costs or origination points, but these options usually come with higher interest rates or other fees.

Sometimes, origination points are negotiable. Homebuyers who have strong credit scores and are able to make a substantial down payment often have considerable negotiation power. Lenders are typically more inclined to reduce origination points for these well-qualified buyers.

In conclusion, purchasing mortgage points can be a valuable strategy for homebuyers seeking to reduce the long-term cost of their mortgage. However, it's essential to understand the mechanisms and potential benefits of mortgage points fully, as well as the distinction between discount points and origination points, before deciding if they're right for you.