Demystifying Mortgage Points: What They Are and How They Work

There is an often misunderstood concept in the world of mortgages: mortgage points. Here’s a question: What are points on a mortgage? Put simply, they are fees paid directly to the lender at closing in exchange for a reduced interest rate. This article will seek to demystify this puzzling topic, making it as simple as understanding the ingredients in your favorite meal.

1. Understanding Mortgage Points

Mortgage points, also known as discount points, might seem like an enigma wrapped in a riddle, yet they are a straightforward concept. Picture yourself at an amusement park. Just as you would purchase fast-track passes to enjoy rides quicker, you buy mortgage points to “speed up” your mortgage repayment process. Essentially, you’re prepaying interest to secure a lower rate over the life of your loan. But unlike the amusement park, this is no trivial matter. It’s a long-term financial commitment.
When you opt for mortgage points, you essentially pay the lender a portion of your interest upfront. In return, the lender rewards you with a lower interest rate on your mortgage. This reduction in interest can lead to significant savings over the years.
SoFi experts say, “Paying points on a mortgage loan can lower your monthly payment.”

2. Types of Mortgage Points

There are two kinds of mortgage points to grasp: discount points and origination points. Like two sides of a coin, they serve different purposes. On one side, they’ve discussed discount points so far. They’re used to buy down your interest rate, offering long-term savings.
Flip the coin, and you find origination points on the other side. These points are used to cover the costs of lending you the money. Think of them like service charges at your favorite restaurant; they’re the cost of doing business. They do not, however, reduce your interest rate.

3. The Math Behind Mortgage Points

Each mortgage point typically costs 1% of your mortgage amount. So, if your mortgage is $200,000, one point equals $2,000. But how does this affect your interest rate? The rule of thumb is that your interest rate is reduced by about 0.25% for each point purchased. It’s like a seesaw; as one side goes up, the other comes down.

4. When Buying Mortgage Points Makes Sense

Determining when to buy mortgage points can feel like deciding on the perfect moment to take an umbrella. It largely depends on your financial situation and how long you plan to stay in your home. If you plan to live there long term, buying points might be advantageous, allowing you to pay less over the life of the loan.
However, if your stay is short, you might not reach the break-even point where the interest savings offset the upfront cost of buying points. It’s like buying a lifetime pass to a gym and then moving away after a month. You wouldn’t get your money’s worth.

5. Considerations Before Buying Mortgage Points

Do your due diligence before jumping into the deep end and purchasing mortgage points. Check whether you can afford the upfront cost, calculate the potential savings, and consider how long you intend to stay in your home. You wouldn’t take a long journey without first checking the fuel in your car, would you? Similarly, consider these points before making this significant financial decision.
Understanding mortgage points is like deciphering a new language; it’s complex at first, but with time and patience, it becomes second nature. The key is to ask the right questions and seek guidance when needed. When it comes to your mortgage, knowledge truly is power.