While trying to find the best mortgage rate, you might notice that a some rates are dependent on paying a certain number of points. The point system is a common practice in the US mortgage world and can be used to lower or raise your interest rate, depending on your goal. How much a point is valued depends on the lender and the market conditions. Mortgage points can be broken down into two separate categories:
Discount points allow you to pay a one-time fee at closing in exchange for a lower mortgage rate. It is typical for lenders to allow you to purchase anywhere from one to three discount points. Discount points help you save money over time; so the longer you stay, the more discount points save you. Another bonus about discount points is that they can be tax deductible.
These fees are used to cover all the work that the lender, broker, processors, and underwriters do in reviewing, processing and approving mortgage loans. A flat fee, determined by the bank, is normal along with any broker processing fees.
It is rare that origination points are charged by lenders/brokers. Origination points used in this context are really commissions as opposed to the fees explained above to process your loan.
Check with your CPA on whether any of these costs are tax deductible.
Let’s put it in perspective:
Suppose you are looking to purchase a home that has a market value of $412,500, the median price for home’s sold in Lemon Grove. If you take out a 30-year mortgage at today’s rate of 3.5% your monthly mortgage payment would be $1,481.85*. Now let’s see what your options would be for points. The chart below tells you how many points you’ll be charged in order to achieve a specific rate or to receive a certain lender credit. The red is what you are charged during closing to achieve that rate and the green is what you are credited during closing after taking a higher rate. Remember, you are starting at a base rate of 3.5%:
Want to lower your payments?
Let’s say that you decide that you want a rate of 3.250. That means that at closing (in addition to your closing costs) you will have to pay 1.117 points or $3,686.10. This would reduce your payments to $1,436.18 (which is $45.67 less each month). After 81 months you’ll reach your “break-even point”, which is when you’ll start to see actual cost savings. The key point here is that you save more from discount points the longer you stay.
When considering whether you want to pay for discount points you’ll want to take into consideration factors such as how much you can afford each month, how long you plan on staying at your home, and how much you can pay upfront.
Want money to pay for closing costs?
Suppose you need help paying for closing costs. One option you have at your disposal is a lending credit. You are essentially paying the lender “points” and taking a higher rate to get money back. Let’s say that you want $5,626.50 to pay for closing costs. Because of this, you are willing to accept a rate of 3.750%. In return for this money you receive at closing, your monthly payments will payments will go up to $1,528.28 (which is $46.43 more each month). In this example, you receive an additional $4,098.60 in lender credits compared to the $1,527.90 credit you receive at 3.500%. The break-even using this scenario is 88 months; if you stay in the home, or do not refinance, for more the 88 months (7 years 4 months) then the lower rate makes more sense.
*This example assumes a credit score of 720 and that you put 20% down on a single family home.