Mortgage Points: What Brokers Need to Know

Homebuyers often look for ways to make their mortgage more affordable, whether by reducing monthly payments or lowering overall interest costs. Mortgage points may offer a strategic option to achieve these goals. By paying upfront fees, known as points, borrowers can buy down their interest rate, leading to lower monthly payments and potential savings over the life of the loan. Mortgage points can be discount points or origination points. Discount points are paid to the mortgage lender to reduce the interest rate, while origination points cover the lender’s costs in processing the loan.

As a mortgage professional, understanding mortgage points is key to helping clients tailor their loan structure to fit their financial goals. That is why we are here to help you grasp the essentials of mortgage points, including the types, benefits, costs, and potential financial impact, so you can explain them to your clients and guide them to make the right decisions about rate buydowns and cost-effective loan options.

Types of Mortgage Points: Discount Points vs. Origination Points

As we’ve slightly mentioned, mortgage points come in two types: discount points and origination points. It’s important to distinguish between the two. So, let’s take a closer look at each one.

Discount Points

Discount points are a prepaid interest option that provides borrowers an opportunity to lower their mortgage interest rate. It’s like paying upfront for a lower monthly payment. It is a one-time fee, usually equal to 1% of the loan amount, for each point a borrower purchases.

For example, if your client has a $300,000 loan and buys two discount points, they’ll pay an upfront fee of $6,000. In return, they’ll likely get a lower interest rate, which can save them money over the life of the loan. The mortgage rate reduction for each point can vary by lender, but it’s usually around 0.25%.

So, when does it make sense for your clients to buy discount points? It’s a good idea if they plan to stay in their home for a long time. The lower monthly payments and potential long-term savings can outweigh the upfront cost. Additionally, if interest rates are expected to rise, buying discount points can lock in a lower rate before it’s too late.

Origination Points

Origination points are a fee charged by the lender for processing a loan. Unlike discount points, they don’t affect your client’s interest rate. Instead, they cover the lender’s administrative costs, like underwriting, processing, and closing the loan, and do raise the upfront loan cost for the borrower.

A mortgage with one origination point would mean a charge of 1% of the loan amount at closing – $3,000 on the same $300,000 loan.

Origination points can vary between lenders, so it’s important to shop around. You can help your clients compare different lenders and their fees. When choosing a lender, homebuyers should consider the overall cost, including the interest rate and origination points.

Calculating Mortgage Points and Break-Even Analysis

When buying mortgage points, it’s important to understand the costs and potential savings involved. Simple calculations can help here. As mentioned above, each discount point typically costs 1% of the loan amount. So, on a $300,000 loan, one discount point would cost $3,000. However, understanding the cost alone is not enough to determine whether buying points is a good financial decision. This is where the break-even period analysis comes into play. The break-even period helps assess how long it will take for the monthly savings from the lower interest rate to offset the upfront cost of the points.

Here’s a simplified way to calculate the break-even period:

1. Determine how much your client will save each month due to the lower interest rate.
2. Divide the upfront cost of the points by the monthly savings to find the number of months it will take to break even.

Example of Mortgage Points Calculation

If a borrower has a $300,000 loan and buys two discount points, they’ll pay an upfront fee of $6,000 (since each point costs 1% of the loan amount). Assuming the points reduce their interest rate from 4.5% to 4.0%, here’s how we calculate the monthly savings.

Original monthly payment (at 4.5% interest): For a $300,000 loan at 4.5% over 30 years, using the formula M = P[r (1 + r)n]/(1 + r)n – 1, we get the approximate monthly payment of $1,520.

New monthly payment (at 4.0% interest after buying points). With the interest rate reduced to 4.0%, the monthly payment becomes approximately $1,432.

Monthly savings. The difference between the original and new monthly payments is:

1,520 − 1,432=88

So, the borrower saves $88 per month with the lower rate.

Break-even period. To find the break-even period, we divide the $6,000 upfront cost by the $88 monthly savings. This results in approximately 68 months (or about 5 years and 8 months) to break even.

Break-even period = Upfront cost / Monthly savings

To make this calculation more accurate and faster, you can use mortgage points calculators (e.g., Bankrate Mortgage Points Calculator, NerdWallet Mortgage Points Calculator, Mortgage Discount Points Calculator). These online tools can help you input the loan amount, interest rate, and the number of points a borrower is considering. The calculator will then estimate the monthly payments with and without points, as well as the break-even period. As a mortgage professional, you can use these tools to help your clients estimate the impact of purchasing mortgage points. You can explain the concept of break-even analysis, show them how to use a calculator, and discuss the factors that can influence their decision, such as their expected length of homeownership and their financial goals.

Advantages and Disadvantages of Purchasing Mortgage Points

Advantages

Purchasing mortgage points can offer several advantages. First and foremost, it can lead to significant long-term interest savings. Even a small reduction, like 0.25%, can result in thousands of dollars in interest savings over the life of the loan. For example, on a $300,000 loan with a 30-year term, lowering the interest rate from 6% to 5.75% could save a borrower over $15,000 in interest payments.

Secondly, buying points can make monthly mortgage payments more affordable. A lower interest rate translates into lower monthly payments, which can improve your client’s cash flow and overall financial health. For example, according to Zillow, “A recent analysis of data from the Home Mortgage Disclosure Act (HMDA)1 by Zillow Home Loans finds nearly 45% of conventional primary home borrowers opted to purchase mortgage points in 2022 as a way to reduce their monthly payment.”

Finally, in some cases, the upfront cost of buying points may be tax-deductible. This translates into a potential tax benefit for the borrower, reducing their overall tax liability for the year. However, it’s important to note that not all points are tax-deductible. The points must be paid solely for the use of money, meaning they cannot be used to cover fees for services like appraisals or title searches. Additionally, the deduction is typically spread out over the life of the loan rather than being claimed all at once.

Disadvantages

While purchasing points can offer these benefits, it’s not without its drawbacks. One of the main disadvantages is the upfront cost. Buying points requires a significant upfront investment, which may not be feasible for all borrowers. It’s essential to weigh the potential long-term savings against the immediate expense.

Another disadvantage is that buying points may not be worth it for short-term homeowners. If your client plans to sell their home within a few years, the upfront cost may not be recouped through lower monthly payments.

Finally, there’s an opportunity cost to consider. The funds used to buy points could instead be invested elsewhere, like in retirement savings or paying down higher-interest debt. It’s important to weigh the potential returns from those other uses against the long-term savings from buying down the mortgage rate. Sometimes, those other goals might offer a better return on investment.

How to Advise Clients on When to Buy Mortgage Points

Buying down points is not a one-size-fits-all option. In some situations, it can be particularly advantageous; in others, the opposite is true.

Buying points is obviously worth it if a borrower plans to stay in the home long enough to surpass the break-even point and if they have sufficient cash reserves for other financial needs. The lower interest rate will save them money in the long run, even though they’ll pay a higher upfront cost. Additionally, when interest rates are high, buying points can be an especially effective strategy. By lowering the rate, borrowers can significantly reduce their overall interest costs and monthly payments. This is particularly beneficial for those with long-term mortgage terms, as the savings can accumulate over time.

On the other hand, if your client is planning to sell their home or refinance within a few years, buying points might not be a good idea. In this case, the savings from buying points may not offset the upfront cost. Thus, it might be more beneficial to keep their funds for other purposes, such as a down payment on a future home or other investments. Also, if your client is struggling to afford the down payment and closing costs, buying points may not be feasible. It’s important to prioritize their immediate financial needs and avoid stretching their budget too thin.

Overall, it’s also important to consider your client’s financial picture. If using those funds elsewhere will have a greater impact, it might not be the right choice to buy down the rate.

Balancing Savings and Mortgage Points

To help your clients decide whether to use savings to buy points, you can use this decision flowchart:

Step 1: Break-Even Point

Q: Will your client stay in the home long enough to benefit from buying points?

• Yes. Calculate the break-even period. If the client expects to hold the mortgage beyond this period, buying points may be a good option.
• No. If they plan to sell or refinance soon, buying points likely isn’t beneficial, as they won’t recoup the upfront cost through monthly savings.

Step 2: Opportunity Cost of Savings

Q: Could your client achieve a higher return on their savings by investing elsewhere (e.g., in the market or paying down other debt)?

• Yes. Compare the potential returns. If other investments or debt repayments offer a better return, keeping their savings liquid may be wiser.
• No. If their options for higher returns are limited or they want guaranteed savings, using funds to buy points may be effective.

Step 3: Financial Goals and Emergency Savings

Q: Does your client have other savings goals or need an emergency fund?

• Yes. If they lack a sufficient emergency fund, advise them to prioritize this over buying points to maintain financial flexibility.
• No. If their savings goals are met and they have emergency funds, they can more confidently use extra cash to buy points.

Communicating the Costs and Benefits of Mortgage Points to Clients

When explaining the value of mortgage points to your clients, clarity and simplicity are key. Break down both the costs and benefits of mortgage points in a straightforward manner, emphasizing the long-term perspective, especially for those who plan to stay in their homes for many years. Explain the concept of the break-even point in simple terms. Use technology to make this information more accessible: tools like mortgage points calculators, break-even charts, and visual aids can help clients clearly see how buying points affects monthly payments and total interest over time. These tools make it easier for clients to understand the numbers and see the potential long-term impact.

Key Takeaways

• Mortgage points can be a valuable tool for you to help your clients tailor their mortgages to their specific needs.
• By understanding the different types of points and their potential impact, you can provide clear and concise explanations to your clients.
• When discussing mortgage points, keep it simple.
• Use real-world examples and mortgage calculators to illustrate how points can save clients money over time and help them visualize the potential benefits and costs.
• It’s important to remember that not every client will benefit from buying points.
• Consider their unique financial situation, including their long-term goals and risk tolerance. By doing so, you’ll help your client secure favorable loan terms and build a foundation of lasting trust.

Frequently Asked Questions (FAQ) Section

What are mortgage points and how are they used to lower the interest rate?

Points are prepaid interest that borrowers can pay at closing to lower their mortgage interest rate. One point costs 1% of the loan amount and typically reduces the rate by about 0.25%. This can benefit buyers who plan to stay in their homes for a long time, as the reduced interest rate leads to lower monthly payments and long-term interest savings.

Are mortgage points worth it?

Whether mortgage points are worth it depends on a borrower’s individual financial situation and long-term goals. If they plan to stay in their home for an extended period, buying points can lead to significant long-term savings. However, if they plan to sell or refinance in the near future, the upfront cost may not be worth the potential savings.

How many points should a borrower buy?

The number of points to buy depends on the borrower’s budget and desired interest rate reduction. Each point typically lowers the interest rate by 0.25%. A borrower should consider their financial situation and the break-even point to determine the optimal number of points to purchase.

Are mortgage points tax-deductible?

In some cases, the upfront cost of buying points may be tax-deductible. However, the specific rules and eligibility criteria vary. A borrower should consult with a tax professional to determine if they can claim a deduction.

Can a borrower buy points later?

No, a borrower cannot buy points after closing on their mortgage. The decision to buy points must be made during the loan origination process.