Definition
Points (also called discount points) are optional upfront fees paid to a mortgage lender at closing to reduce the loan’s interest rate. Each point typically costs 1% of the loan amount and lowers the interest rate, resulting in lower monthly mortgage payments over the life of the loan.
Explanation
Buying points is often referred to as “buying down the rate” and can be beneficial for borrowers who plan to stay in their home long enough to break even on the cost of the points through monthly savings.
There are two main types of mortgage points:
- Discount Points – Paid upfront to reduce the loan’s interest rate.
- Origination Points – Fees paid to the lender for processing the loan (not related to lowering interest rates).
The amount the interest rate is reduced varies by lender and market conditions, but generally:
- 1 point (1% of the loan amount) = 0.25% rate reduction
- 2 points (2% of the loan amount) = 0.50% rate reduction
Example
A borrower takes out a $300,000 mortgage with an interest rate of 6.5%. They have the option to buy 1 discount point for $3,000 (1% of $300,000), which reduces their interest rate to 6.25%.
- Without points: Monthly payment = $1,896
- With 1 point: Monthly payment = $1,847
- Monthly savings = $49
If the borrower plans to stay in the home for more than 5 years, they will break even on the upfront cost and save money in the long run.