If you're shopping for a home mortgage, you've probably seen the term "mortgage points." Before you take the next step to sign a mortgage preapproval or other borrowing commitment, it's critical to understand how points work.
Taking out a mortgage is a big financial decision, so don't miss the opportunity to take advantage of mortgage points when it's wise for your situation. Paying points can help you get the best deal possible on your next new home.
1. Why mortgage points can help home buyers
Mortgage points, also known as discount points, reduce the interest rate you pay on a home loan. While you must pay them upfront, they typically save money over time.
Every mortgage point you buy reduces a loan's annual percentage rate (APR) by 0.25%. So, if the original APR is 4.5%, paying one mortgage point knocks it down to 4.25%. Paying two points reduces the rate to 4%, and so on. So, the more points you buy, the lower your interest rate.
For example, if you're shopping for a $300,000, 30-year, fixed-rate mortgage at 4.5%, your total interest would be $247,220. But if you bought three mortgage points, your 3.75% rate would mean paying $200,165 in interest. That's a massive interest savings of more than $47,000 over the life of the loan!
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2. How much home buyers pay for mortgage points
One mortgage point typically costs 1% of your home loan amount. So, if you want to borrow $300,000 to buy a property, one mortgage point would cost $3,000. You'd have to pay $6,000 for two and $9,000 in the previous example with three points, and so on.
Most homebuyers who opt for points buy between one and three and have the option to purchase fractions of points. However, the challenge for buyers is that lenders typically require you to pay points up front. Since the cost gets included in the total amount you must bring to the closing, you must have it in savings.
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