Buying or Selling a Home

What are mortgage points?

Written by Whitney Bennett

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What are mortgage points?

When you’re getting ready to buy a house, one of the first things that you’re going to research is whether you can afford one! The first step before you begin looking at homes is to get pre-approved for a mortgage so you know what price range you can afford.

Landmark Home Warranty has numerous articles on getting to this point that you may want to read before we continue. They are listed below:

How and why you should get pre-approved for a mortgage before shopping for a home.

What the difference is between getting pre-approved versus committed to a mortgage.

Once you’ve found a home and you’re ready to finance the purchase, you need to look a bit more seriously into the different mortgage types, rates, and terms. As you begin to research which mortgage option is best for you and your future home, you’ll probably hear the phrase “mortgage points” or “buying down the rate.” Mortgage points can be difficult to understand, so let’s walk through them together.

What are the different types of mortgage points?

There are two types of mortgage points.

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There are two main types of mortgage points: positive points and negative points.

Positive Mortgage Points – Buying Down the Rate

Positive mortgage points are usually used to get a lower interest rate on a loan. This is when you’ll hear the term “buying down the rate.” You can purchase mortgage points to reduce your interest rate.

When you get a loan for a home, you have the principal, or the amount of money you’re borrowing to purchase the home, and the interest rate, which is the percentage of that principal you pay to the mortgage company for the privilege of borrowing the money. Both a portion of the principal and interest make up your monthly mortgage payment. An interest rate is how lenders make a profit; they make money off the interest you’re paying.

What are positive mortgage points?

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Now, all lenders are different, but some will offer positive “points” that you can purchase up front to reduce that interest rate. If purchased, these points do not mean you’re paying money on the principal like a down payment. Instead, you are paying interest payments up front for a smaller interest rate on the rest of your mortgage.

Usually, mortgage points are sold for about 1% of the purchase price or principal of the loan. It depends on the lender, but for each point purchased, the interest rate will go down between 0.25 and 0.5 percent.

Why purchase positive mortgage points?

Reducing the interest rate on your loan will save you money each month and could make it so you pay less money in the long run.

Let’s look at an example:

You can save money if you buy mortgage points.

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You’re looking to purchase a home and you’ll need to borrow $200,000. This is your principal. The loan is for 30 years at a 5% interest rate. You can use this equation to determine what your monthly payment (P) will be, OR you can use the numerous mortgage calculators on the internet that will do this for you!

 P = A / D

Where: 

A= Principal amount

D= {[(1 + i) ^n] - 1} / [i(1 + i)^n]}

i= Annual percentage rate divided by the number of payments each year (12). 

n= Number of payments you’ll pay.

$200,000/ {[(1 + (.05/12)) ^360] - 1} / [(.05/12)(1 + (.05/12))^360]}= $1,074

With a $200,000 loan and a 5% interest rate, you’ll have a $1,074 mortgage payment each month. So, say your lender offers you the choice of paying a point to reduce your mortgage rate by .25%. You choose to pay 2 points. At 1% of your purchase price, each point is $2,000.

If you pay $4,000, you end up getting a 4.5% interest rate, which means your monthly payment reduces to $1,013. You’ll be saving $61 a month.

How do you know if paying points is worth it?

Positive points are worth it depending on how much you save and how long you stay in the home.

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Fortunately, there is a simple answer: it depends on how long you plan on staying in the home. If you plan on living in the home and the savings on your mortgage each month break even on the points you purchased in the beginning, it is worth it! If you are planning on staying for a shorter amount of time, purchasing points isn’t worth it.

Let’s go back to the original example:

You paid $4,000 for two points. With savings of $61 a month, you would need to stay in the home 66 months, or 5.5 years, to have those monthly savings add up to over the $4,000 you originally paid. If you’re planning on staying in the home for 5.5 years or more in this situation, buying positive points to buy down the mortgage rate is a good idea!

Negative Mortgage Points

What are negative mortgage points?

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Some positive mortgage points are included up front as a part of closing costs. These mortgage points usually are paid to the lenders as a loan origination fee. These may be removed by letting the lender increase your interest rate, and essentially reversing the positive mortgage point system.

Just like how you can pay interest up front by buying positive points to reduce your monthly payments, some mortgage lenders will sell you negative mortgage points to reduce upfront costs.

To reduce closing costs, loan origination fees, and more, some lenders will apply a higher interest rate to your loan in exchange for negative points that remove some of the closing costs up front. Those costs are amassed into your loan, you just don’t have to pay them up front anymore.​​​​​​​

​​​​​​​What is a mortgage point?

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Buying or Selling a House

Looking to buy or sell a house? Are you a real estate professional seeking helpful resources to educate your clients? These articles will help walk you through the process of buying or selling a home.

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