A point is simply 1% of the loan amount. It is usually paid in a lump sum when you get your loan. In some cases it may be financed. There are two types of points:
1. discount points, which can directly lower your interest rate; and,
2. origination points.
Example: You want to borrow $150,000. One lender offers a no points loan with an interest rate of 6%. Another lender offers a two points loan at 5.5%. By paying the two points, you are buying down the interest rate. Which loan is better?
There are two things you must consider to determine the answer to the problem in the example. First, type “mortgage points” into any search engine. There will be several sites for mortgage calculators. For the example, the monthly payment on a thirty-year loan would be just under $50 less per month on the two point 5.5% loan. It would take a little over five years to make the two points loan the better deal. Type in your specific numbers and you will be able to figure out the break-even time for the loan amount and percentages you are comparing.
Now for the harder part. How long will it be before you pay off the loan? Are you planning to move within five years (before the break-even time)? If you plan to move in three years, you would want the no points, 6% loan. If you end up staying in the property seven years, you will save money with the two points, 5.5% loan. While predicting when you will move in the future is no easy task, most people underestimate the time they will keep their property.
An advantage to discount points is that they are considered interest and are currently tax deductible. Since tax laws change frequently, always get advice or research current deductions for mortgage expenses before filing.
A buydown over the life of a fifteen to thirty-year loan will not cause a significant difference in your interest rate. The estimate on a thirty-year loan, for example, is one-eighth of 1%.
The buydown is most effective over a short period. If you buy down your interest rate for the first three to five years of your loan, the rate and monthly payment will drop enough that it may mean the difference between qualifying and being rejected.
The second type of point is the origination or commission point. These are lender fees or mortgage broker commissions. They do not lower your interest rate or any other costs of the loan. They are necessary payments for the service that you receive. However, avoiding these fees may not save you money. Paying a fair commission to an honest and competent mortgage broker may be insignificant compared to the money he or she will save you on your mortgage loan.
Since the lender will give more weight to lowering your monthly payment than having some cash in the bank, you can accomplish more by using available cash to buy down the interest rate.