What Are Points?
What are mortgage points? And is paying mortgage points worth it? A “point”— formally referred to as a “discount point”— costs the borrower one percent of the loan amount. Mortgage lenders typically refer to this as “buying down your rate.” For example, one point on a $500,000 loan is $5,000. The point is a fee typically paid at the beginning of the loan in most cases and it is up to you as to whether you opt to pay for discount points.
When a lender looks at the available daily rates, they see many different rates – not just one for each loan program or purchase price. Some rates carry discount points (which cost you) and other rates generate rebates known as a lender credit (from the lender) which gives you money back. The lower the rate, the higher the points. A rate without discount points or lender credits applied is referred to as the “par rate.”
If you choose to pay points, you will get a lower interest rate for as long as you have the current loan (called a “permanent buy-down”), meaning that the effect of the up-front fee lasts for as long as you have the loan. As a general rule, you will get a rate about .25% lower if you pay one point. For example, if you are applying for a $500,000 loan, paying an additional $5,000 upfront would reduce your rate from 3.75% to 3.5% and your monthly payment would be $70 lower.
Negative Points (Lender Credits)
Lender credits affect rates in much the same way that points do but in the opposite direction. Typically, if a lender increases the rate by 1/4%, they will be able to offer a closing cost credit of approximately 1% of the loan amount. The exact amount of the credit again depends on market conditions.
Your lender will tell you that by selecting a higher interest rate, you will receive a rebate at closing and you would have to pay less cash to close in escrow. Just like how paying one point will drop your interest rate .25% below the par rate, raising your rate .25% above it would garner a lender rebate of around 1% of the loan amount—a $5,000 credit at closing in exchange for a slightly higher monthly payment.
If the “par pricing” is 3.75%, the monthly payment for a $500,000 loan would be $2,316. Paying $5,000 to buy the rate down to 3.5% would decrease your monthly payment by $70 to $2,245. Selecting a 4% rate (above par) would give you a lender credit of about $5,000, but at a cost of $70 per month over the par rate. If you are struggling to scrape up enough cash to buy a home, a $5,000 rebate could be a game-changer.
We encourage borrowers to take advantage of lender credits whenever cash is tight because they can always refinance into a lower rate six months after closing. The risk of course is that rates might increase and buyers will then be stuck with the higher rate.
So, Should You Pay Points?
We recommend reading this article written by JVM’s founder and broker – To Pay Points, or Not to Pay Points. He lays out the pros and cons of paying points, as well as when paying points makes the most sense for your unique financial situation.
If you are still on the fence, you can run through some different scenarios using this Mortgage Points Calculator.
We typically don’t recommend paying points because we think buyers get too little bang for their buck; paying points depletes cash reserves; and buyers often end up refinancing long before they make up the points with their interest rate savings.
JVM Lending is a top-rated mortgage lender based in Walnut Creek, California, with additional offices in Sacramento, California, Austin, Texas, and Dallas, Texas. We can provide mortgage services for any properties located in California, Texas, and Arizona. Please contact us if you have mortgage-related questions!