Mortgage 101: Mortgage Points, Defined and Explained
While you may not have heard of them before, mortgage points could prove to be the difference between you affording the home of your dreams or having to settle for something less attractive. Here, we examine mortgage points in finer detail so you can be as informed as possible when entering negotiations with your mortgage lender.
What Are Mortgage Points?
A mortgage point is a fee that’s paid by the buyer in order to reduce the amount of their monthly mortgage payment through their interest rate. Essentially, paying points up front lowers the interest rate for the duration of the loan. Mortgage points can sometimes be referred to as discount points or interest points, and in most loan configurations, one “point” is equal to one percent of the total loan value. The more mortgage points you pay, the lower your interest is going to be, thereby reducing your monthly payment.
How Do Mortgage Points Differ From the Down Payment?
Mortgage points and down payment are both paid at closing but go toward different parts of the loan. The down payment is subtracted from the total sale price of the home, while mortgage points are essentially prepaid interest, and are included in the closing costs. Another way these two components differ is that mortgage points are tax deductible, while down payments are not.
What Are the Benefits of Paying Mortgage Points?
The most significant benefit of paying mortgage points at closing is the reduction in the loan’s interest rate and subsequent lower monthly mortgage payment. By taking advantage of this feature, mortgage points can enable a buyer, who might otherwise be unable to afford the home they want, to reduce the amount of their monthly payment to a number that they can afford. Thus, they get the house they want at a price that fits better within their budget.
Buying Mortgage Points Isn’t Right for Everyone
As attractive as lowering your monthly mortgage payment might be, there are some situations where paying mortgage points might not be the ideal choice. For example, if you know that you are going to be struggling to meet the estimated mortgage payment even after your down payment is subtracted then you should probably choose a home that’s more in line with your budget rather than put more money into points. This way you don’t risk your future financial health. Paying discount points is most effective for those who are buying a home that is just out of their reach, but who have cash on hand to pay toward the points in order to position the monthly payment more comfortably within their means.