Point (mortgage)

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A point, sometimes also called a "discount point", is one of the important factors in the calculation of the annual percentage rate for a mortgage loan. Points may be purchased at closing at a rate of one percent of the loan amount per point. For each point purchased, the loan rate is typically reduced by 1/8% (.125%).^[1]

If for a $100,000 loan, the [percentage] points are 1.5, then one pays $1,500 in points because $\frac{1.5}{100}\times\$100,000=\$1,500$ .

To determine the break even time frame, determine the payment difference and use that number to divide the $ amount of points paid.

Using the above example:

If the rate without paying points was 6%, a loan of $100,000 fixed for 30 years costs $599.55 per month in Principal & Interest (P&I).

If paying 1.5 points reduces the rate by .5% (or 50 basis points or 'bps' [pronounced bips]) the new payment is calculated using a 5.5% rate, or 567.79 per month.

The 5.5% rate costs $1,500 in points, and saves $31.76 / month. $1,500 / $31.76 = 47.23 months, or (divide by 12) 3.94 years. If you leave the house before 3.94 years, you wasted money.

Now on the other hand, 360 months (30 years) - the 47.23 months is the upside, or 312.77 months. Should you keep this loan for 30 years until paid off, you saved $9,933.58 over the life of the loan by paying $1,500 in points (312.77 months x $31.76 monthly savings from lower rate).

Discount points are not to be confused with an origination or broker fee. Discount points differ from origination fees in that discount points are used to buy down the interest rates, temporarily or permanently. Origination Fee and Discount Points are both items listed under lender-charges on the HUD-1 Settlement Statement.

The difference in savings over the life of the loan can make paying points a benefit to the borrower. If you intend to stay in your home for an extended period of time, it may be worthwhile to pay additional points in order to obtain a lower interest rate. Any significant changes in fees should be re-disclosed in the final Good Faith Estimate (GFE).

Also directly related to points is the concept of the 'no closing cost loan'. There are other aspects of such a proposal, this example only serves to illustrate how points and rate directly affect the proposed loan:

If points are paid to acquire a loan, it is impossible at the same time for a broker bank or lender to make a premium for a higher rate. When premium is earned by making the note rate higher, this premium is sometimes used to pay your closing costs. It is usually harder to do the math without a point of reference: but you can compare the lower rate and payment with a fee versus the higher rate payment with no fee.

Using the above example (notice it is similar math as above but in the other direction):

Suppose the origination fee in the above example is 1.5% for the 6% interest rate, but you do not want to 'pay' (if a purchase you typically pay out of pocket, it can be rolled into the loan amount if a refinance) the fee. This makes sense for a purchase in most cases to avoid out of pocket expenses, the fee is paid via the interest rate.

For example: In order to make up for this 1.5% of lost fee, the lender may provide an option for a 6.5% rate. The payment is $632.07 per month, or $32.52 more per month. This is to avoid having to pay the 'fee' of $1,500 (Loan amount x fee %). $1,500 / $32.52 = 46.13 months or 3.84 years. The avoidance of a one time fee costs you 313.87 months worth of the extra $32.52 monthly payment, or $10,207.05 over the life of the loan. If you sell the collateral or refinance before the 3.84 years you come out ahead.