Unless you were recently rescued from a desert island or returned to earth from deep space, you’ve probably heard the news that mortgage interest rates have been on the rise. In fact, the average rate on a 30-year fixed-rate mortgage has almost doubled since the beginning of the year. But buyers who have been battling rising rates aren’t entirely powerless against the trend, and one tool for locking in below-market rates has been gaining favor – mortgage points.
Mortgage points haven’t been in the home-finance conversation for a while because interest rates have maintained a historic downward trajectory for the past 15 years. However, in today’s rising-rate environment, “paying points” is worth a closer look.
What Are Mortgage Points?
Mortgage points are a fee a borrower pays a mortgage lender to lower the interest rate on their loan. A point equals 1 percent of the loan amount. So, for example, 2 points on a $300,000 mortgage would cost $6,000. Each point generally lowers the interest rate by .25 percent, so 2 points on a 5.5 percent interest rate would lower the rate to 5 percent. This can also vary based on the type of loan.
Here is an example of how discount points can reduce costs on a $300,000, 30-year, fixed-rate mortgage:
| Loan Principal | $300,000 | $300,000 |
| Interest Rate | 5.5% | 5% |
| Discount Points | None | 2 @$3,000 each = $6,000 |
| Monthly Payment | $1703 | $1610 |
| Interest Total | $313,212 | $279,767 |
| Lifetime Savings | None | $27,445 |
When Should You Pay Points?
There are a couple of factors to consider if you’re contemplating buying down your interest rate. According to Kyle Gillespie, senior vice president of mortgage lending for Proper Rate, “You want to make certain you’re not in a declining rate environment because if rates are expected to drop in the near future, you would have a chance to refinance before realizing the financial benefits of the points you purchased,” he said.
Gillespie added that it’s important to understand the “recapture timeframe” of buying down your interest rate and have a good idea of how long you’ll be in your home. “Your mortgage professional can help you figure out how much it will cost you and how long it will take you to recoup that money,” said Gillespie.
The easiest way to calculate this breakeven point accurately is to simply take the percent in points paid and divide by the percent in rate drop. Using the above example:
2%/.5% = 4 years
In this case, the borrower would have to stay in the home for about four years to recover the cost of the discount points.
Much of the decision on whether to purchase mortgage points is based on your personal financial situation. However, points provide a good option in a rising rate environment, for buyers with a longer time horizon who want a lower monthly payment.
