What are mortgage points?
In short, a mortgage point is a fee that is calculated based on a percentage of the loan amount. One point equals one percent of the mortgage amount. For example, if you pay one point on a $100,000 loan, the cost is $1,000 ($100,000 * 1% = $1,000). If you pay two points, the cost is $2,000 ($100,000 * 2% = $2,000). If you pay a half a point, the cost is $500 ($100,000 * 0.5% = $500). You can pay any number of points, including fractions of points but they are usually charged in half point increments. There two types of mortgage points: discount points and origination points, which are sometimes referred to as origination fees instead.
A discount point is a fee that you pay to obtain a lower mortgage rate than you would otherwise receive. A discount point typically equates to .250% in mortgage rate so if a lender quotes you a 4.000% rate with no points, your rate should be 3.750% if you choose to pay one discount point. Your rate should be 3.500% if you choose to pay two discount points, and so on.
Review Should You Pay Discount Points?
Paying a discount point is effectively pre-paying a portion of your interest expense. Instead of paying that interest over the course of your mortgage, you pay for it up front with a one-time fee at closing. By reducing your mortgage rate, you lower your monthly mortgage payment, which enables you to recover the cost of the discount point over time.
Because it takes time to recoup the cost of the point, it typically does not make sense to pay discount points if you are going to have your mortgage for a relatively short period of time -- five and a half years is a good rule of thumb. If you are going to have your mortgage for at least five and a half years, then paying discount points usually makes financial sense, depending on your mortgage rate and loan term. The longer you have your mortgage, the longer you benefit from the lower monthly payment associated with the lower rate.
Use our Discount Point Calculator to determine if you should pay discount points
It is important to emphasize that paying discount points is completely optional for borrowers. A lender can never require or force you to pay discount points.
The second kind of mortgage point is an origination point. Some lenders charge origination points, or fees, to process and close your mortgage. Unlike discount points, origination fees are not directly related to your mortgage rate, but they are highly correlated. The higher the origination points charged by the lender, the lower your mortgage rate should be.
Another difference between origination points and discount points is that lenders can require you to pay origination points, at least if you want to work with that lender. You can always attempt to negotiate to reduce or eliminate origination points but lenders have the discretion to adjust their loan terms as they want and they may or may not be flexible. Although the lender is not required to lower or remove the origination point, you can always choose to work with a different lender that charges lower fees, which is the ultimate negotiating tactic.
Please note that both discount and origination points are both tax deductible, up to applicable limits. We advise you to consult a tax specialist or accountant to understand how mortgage-related tax deductions apply to you.
In sum, the decision to pay discount points is up to you, the borrower, while the decision to charge origination points is up to the lender. Regardless of the type of mortgage point, we recommend that you contact multiple lenders to find the lowest combination of mortgage rate and closing costs. The table below shows interest rates and fees, including points, for leading lenders in your area. Shop multiple lenders, compare proposals and select the best mortgage terms.
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Sources
“What are (discount) points and lender credits and how do they work?” CFPB. Consumer Financial Protection Bureau, August 3 2017. Web.
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