The interest rate on a loan is the primary factor determining your payment and how much you pay the lender over the life of the loan. Did you know that in some cases you can pay to reduce the interest rate on your mortgage loan? The process is called "buying points". The more points you buy the higher your closing costs are but the lower your payment and interest rate is.

If you are planning to keep the loan for a long time, buying points can make a lot of financial sense. Then again if you sell or refinance too soon the points are a waste.

Curious to know more? This post discusses everything you need to know about buying points on a mortgage loan including examples.
 

Points on a Mortgage Loan

When applying for a mortgage in some cases you can opt buy points from the lender to trim the loan's interest rate. This is also known as buying down the rate.

A general rule of thumb with mortgage points is: Each point you buy from your lender costs 1% of the mortgage amount and reduces the interest rate by 0.25%.
 

Examples of Points on a Mortgage Loan

Here is a table to help you understand how buying points on a mortgage loan impacts the outcome. For example, consider a 30 year loan of $200,000 with various point purchases:

The more points you buy, the lower your payment is, which means more cash in your pocket.

In this example it will take 68 months to recoup the up front cost on a cash basis (considering monthly payments only).

• $2000 / $29.49 = 67.82 or ~68 months
• $4000 / $29.49 = 68.33 or ~68 months

That said, after 68 months, the loan balance will be lower as well because the loan compounds to a lesser degree with a lower rate. When accounting for the lower interest rate and the effect of compounding the break even is actually ~49 months.

So if you are planing to keep the loan for at least 49 months either option would pan out.

The savings over the life of the loan are pretty nice too - $10,616.4 and $21,074.4 for 1 point and 2 points, respectively.

Note that this analysis does not include what you could earn if you invested the $2,000 or $4,000. Over 30 years, you would need to earn a rate of ~5.7% to get the same payback. So points look pretty attractive for people who hold the loan for its entire duration.

Things to Consider Before Buying Points on a Mortgage Loan

Points need to be compared with the other adjustments namely the down payment. In general, if you can make a down payment large enough to eliminate PMI (private mortgage insurance) that should take priority. The fees from PMI will exceed any gains from buying points. So, make a large enough down payment to avoid PMI (which is 20%), and then consider buying points if you have money left over.

If you are considering an adjustable rate mortgage (ARM) clarify if the points you buy are for the life of the loan or just the introductory period. Also, calculate the break-even so you ensure it occurs before the end of the initial fixed-rate period.

Can You Negotiate Points Fees on Mortgage Loan?

Yes, you can negotiate points fees on a mortgage loan. It makes sense to get quotes from multiple lenders and ask if any of their figures are negotiable. You can get a better deal if you put down 20% (or more) and have a strong credit score.

 

To Sum Up

To help you cut down on some expenses, you can consider buying points on a mortgage loan if it deems fit. The points ensure that you save money every month with a reduced rate of interest. The break even window is generally a few years, so keep that in mind if you think your may sell or refinance.