How Much Does It Cost to Buy Down Mortgage Points?

When securing a home loan or refinancing, borrowers often encounter mortgage points. These points are an upfront fee paid to the lender for a reduced interest rate. Their primary motivation is to lower overall interest costs over the loan’s life. This article explores the mechanics of mortgage points, detailing their cost and assessing their value.

Understanding Mortgage Points

A mortgage “point” is a fee representing one percent of the total loan amount. For example, on a $300,000 mortgage, one point costs $3,000. There are two types of mortgage points: origination points and discount points. Origination points are fees paid to the lender for processing the loan and covering administrative costs.

Discount points are specifically paid to reduce the interest rate on the mortgage. This practice is commonly referred to as “buying down the interest rate” or a “buydown.” The focus of buying down points is on these discount points, allowing a borrower to pay more upfront to secure a lower interest rate and reduce ongoing monthly payments. By paying a lump sum at closing, the borrower essentially prepays a portion of the interest, leading to reduced payments over the loan’s duration.

Determining the Cost of Discount Points

The direct cost of discount points is calculated as a percentage of the total loan amount. The formula for determining this cost is straightforward: Cost of Points = (Number of Points / 100) Loan Amount. For instance, on a $350,000 mortgage, one discount point would cost $3,500. If a borrower opts for 0.5 points on a $400,000 loan, the cost would be $2,000. These costs are generally paid at the time of loan closing, becoming part of the overall closing expenses.

Factors Influencing Point Pricing and Rate Reduction

The actual reduction in the interest rate achieved per point can vary. Lenders determine how much each point will lower the interest rate, and this reduction is not fixed across all loans or lenders. One point might lower the interest rate by approximately 0.25 percentage points, though this can differ.

Several factors influence how lenders price points and the corresponding rate reduction. Current market interest rates play a role, as the availability or cost of points can shift with market conditions. Lender policies and their individual pricing models also contribute to varied offerings.

The type of loan (conventional, FHA, VA) can affect rules regarding points. For example, fixed-rate mortgages offer consistent savings, while savings on adjustable-rate mortgages could change. The loan term (15-year or 30-year) may also influence the rate reduction. A borrower’s credit score and financial profile determine their initial interest rate, impacting the potential benefit of buying down points.

Calculating the Value of Buying Down Points

To determine if paying for discount points is a worthwhile investment, borrowers should calculate the “break-even point.” This is the period, usually measured in months, it takes for the savings from lower monthly interest payments to equal the upfront cost of the points. A simple calculation involves dividing the total cost of the points by the amount saved on the monthly payment. For example, if points cost $3,000 and save $50 per month, the break-even point is 60 months, or five years.

One consideration is the anticipated time a borrower plans to remain in the home. If a borrower intends to sell or refinance before reaching the break-even point, the initial investment in points may not be recouped. Conversely, staying in the home beyond the break-even point means every subsequent month represents pure savings.

Another factor is the opportunity cost of the funds used to purchase points. Borrowers should consider whether the upfront cash could generate a higher return or provide greater financial security if used for other purposes, such as an emergency fund or alternative investments. Buying points generally yields greater financial benefit over the full term of a long-term mortgage, as cumulative interest savings can be substantial.