How do points affect your mortgage payment?by Keith Gumbinger
First-time homebuyers may make the mistake of only comparing mortgage rates without noticing whether the rate they are reviewing also includes discount points, usually referred to simply as, “points.”
A point is a cost equal to 1 percent of your loan amount–so one point on a $100,000 loan is $1,000.
Mortgage rates and points
Discount points are prepayments of interest that you pay at your loan’s closing. Mortgage lenders offer borrowers a choice of loans at different mortgage rates with different points.
Why pay points?
Typically, the more points you pay, the lower the mortgage rate, and the fewer points paid, the higher the mortgage rate. Some lenders will even pay you points to accept a higher-than-market interest rate! The decision to pay or not pay points depends on your individual financial circumstances, your cash flow, available cash on hand, or even whether you need cash to pay for fees and such.
If your greatest concern is having sufficient funds for a down payment and closing costs, you may be more inclined to choose a mortgage without any points (or even a rebate arrangement, if the rate doesn’t rise too much). While your mortgage rate will be slightly higher, you will need less cash at the settlement.
If, on the other hand, you have enough cash but want to keep your monthly mortgage principal and interest payments as low as possible, you may want to pay additional points at the closing. The more points (prepaid interest) that you pay at the closing, the lower your monthly payments will be.
Since the interest rate on your loan dictates your monthly payment, and your monthly mortgage payment dictates the size of the loan your income can carry, you may need to pay points in order to obtain an interest rate which makes your purchase or refinance transaction fit your budget.
Points and planning ahead
When you are making a decision about whether or not to pay points, you should also think about how long you will be in the home. If you intend to stay in your home for the long term and are financing the property with a fixed-rate loan, it may be most valuable for you to pay extra points so that your mortgage rate is as low as possible for the life of the loan. Paying extra cash at the closing makes less sense if you believe you will only be in the home for the short term.
Consult a mortgage lender to learn more about how points will impact the overall cost of your mortgage.
Michele Lerner contributed to this post.