For anyone who is buying a mortgage, or has gotten a mortgage in the past, you have probably heard of “points”. But what are points on a mortgage? Read this blog to find out.
So, a mortgage point is a fee charged by a lender, there are two types of points. Discount points and origination points. A Mortgage point is equal to 1% of the loan amount. For example, if you have £300,000 loan, a point is £3,000, or 1%. Origination points are a fee charged by the lender to compensate the loan officer. However, not all lenders will charge points. Sometimes, a mortgage point may be referred to as an origination fee, but they are the same thing. On average, most lenders charge approximately 1 origination point. These mortgage points are not tax deductible.
Discount points are pre-paid interest on a loan. For example, discount point you the mortgage rate will be reduced by up to a quarter of a percent. The amount of rate reduction per discount point varies between lenders and market conditions. Because you are paying less interest, your monthly mortgage payments will be lower as well. Most lenders will allow you the opportunity to buy up to 4 discount points.
When is it a good idea to pay for discount points? When deciding whether or not to pay for discount points, you first you need to know how long you plan on living in the home. If you plan on selling the home, or paying off the loan within 5 years then discount points are useless, and could end up costing you more. However, if you plan on staying in the home for a long time using some discount points will save you a lot of money in interest.
For example, on a £250,000 home loan with an interest rate of 4.5% will have a payment of £1,610. If you purchase 4 points for a total of £10,000 bringing your interest rate down to 3.5%, the total monthly payment is reduced to £1,466. This is a savings of £154 per month. Around £1,850 per year. The points will pay for itself in 55 months, and will save you £55,440 over the course of a 30-year loan.
How discount points affect your monthly payment (£100,000 loan amount) Assuming 1/4 rate drop per discount point
Assuming 1/4 rate drop per discount point
0 discount points – Rate 4.5% – Payment £507 – £1,000 upfront
1 discount points – Rate 4.25% – Payment £492 – £1,000 upfront
2 discount points – Rate 4.0% – Payment £477 – £2,000 upfront
3 discount points – Rate 3.75% – Payment £463 – £3,000 upfront
4 discount points – Rate 3.5% – Payment £449 – £4,000 upfront
Deciding whether or not to buy discount points is something that depends on the borrower. Don’t pay for discount points if you know you are not staying in the home for 5 years or more If you plan on staying in the home for more than 5 years then discount points can save you tens of thousands of dollars over the life of your mortgage
The opposite of discount points, lender credits are used to lower the closing costs of a mortgage in exchange for a higher interest rate throughout the life of the loan. Lender credit is essentially extra loan money provided by the lender upfront, which allows some of the initial costs of borrowing money to be pushed off until a later date. These credits are useful for borrowers who are draining their savings to pay a down payment and don't want to pay more in upfront cash.
Lenders typically charge a variety of closing costs, so reducing the initial cash payment can alleviate some financial pressure. However, it's important to remember that buying lender credits will increase your monthly payment. The example below shows the cost difference for buying 1 lender credit at £2,500 to cover the closing costs for a 30-year, £250,000 loan with a 4.5% interest rate. In this example, getting 1 lender credit increases your monthly payment by £37 — which amounts to a total increase of over £10,000.
If you can’t afford to make large up-front payments at the closing of your mortgage application, you may want to keep the current interest rate and refinance your mortgage at a later date. Refinancing a mortgage is basically taking out a new loan to pay off your first mortgage, but you shop for a better interest rate and terms on the new one. This makes sense if you’ve made timely payments on your old mortgage, have paid off a decent amount of your principal, and improved your credit score since you first obtained the initial mortgage.
But if you have some money in reserves and you can afford to make up-front payments, buying mortgage points may suit you. In general, buying mortgage points is most beneficial when you intend to stay in your home for a long time and if you can afford large mortgage point payments.
If this is the case for you, it helps to first crunch the numbers to see if mortgage points are truly worth it.
If you are buying a home and have some extra cash to add to your down payment, you can consider buying down the rate. This would lower your payments going forward. This is also a good strategy if the seller is willing to pay some closing costs. Often, the process counts points under the seller-paid costs. And if you pay them yourself, mortgage points usually end up tax deductible.
In many refinance cases, closing costs are rolled into the new loan. If you have enough home equity to absorb higher costs, you can pay mortgage points. Then you can finance them into the loan and lower your monthly payment without paying out of pocket.
To cut down on your closing’s costs, you can use negative mortgage points instead of positive ones. As a result, however, you’ll be paying more interest.
If you plan to keep your home for a while, it would be smart to pay points to lower your rate. Paying £2,000 may seem like a steep charge to lower your rate and payment by a small amount. But, if you save £20 on your monthly payment, you will recoup the cost in a little more than eight years.
If you expect to make payments on a 30-year loan all the way to maturity, paying points can be a wise financial move.
The lower the rate you can secure upfront, the less likely you are to want to refinance in the future. Even if you pay no points, every time you refinance, you will incur charges. In a low-rate environment, paying points to get the absolute best rate makes sense. You will never want to refinance that loan again.
But when rates are higher, it would actually be better not to buy down the rate. If rates drop in the future, you may have a chance to refinance before you would have fully taken advantage of the points you paid originally.
We have so many questions from our customers asking about why lenders quote an origination fee? Well to get a true “no point” loan, they must disclose a 1% fee and then give a corresponding 1% rebate. Wouldn’t it make more sense to quote a loan “at par” and let the borrower buy down the rate if they choose?
The reasons lenders do it this way is the new disclosure laws that came about. If the lender does not disclose a certain fee in the beginning, it cannot add that fee on later. If a lender discloses a loan estimate before locking in the loan terms, failure to disclose an origination fee (or points) will bind the lender to those terms.
This may sound like a good thing. If rates rise during the loan process, it can force you to take a higher rate. Suppose you applied for a loan when the rate was 4.5%. When you are ready to lock in, the rate is worse. Your loan officer says you can get 4.625% or 4.5% with a cost of a quarter of a point (0.25%).
But if no points or origination charges show up on your loan estimate, the lender wouldn’t be able to offer you this second option. You would be forced to take the higher rate.
Be proactive and get a handle on your credit report and credit score. Both are significant factors in determining if you can get approved for a loan and for how much, which plays into your interest rate and how much you’ll pay each month. There are plenty of free services online that will give you an idea of where you stand. You’re also entitled to a free credit report from the major bureaus each year.
To make sure you’re set up for success, we highly recommend speaking with Stephen Kerrigan, Mortgage Advisor. Our Mortgages Remortgages – Fee Free Mortgage Advisor Calculator tool can link you with up to three lenders in your area in just a few minutes. All you have to do is answer some questions about your financial situation. Then you can check out their profiles, interview them on the phone or in person and choose who to work with in the future.