What are points?
Paying "points" is a common way to reduce the interest rate on a mortgage.
How points affect your monthly mortgage payments
If you reduce your interest rate, you reduce your monthly payment—a key consideration for anyone who's thinking of taking on loan payments for the next 30 years.
A point is equal to 1% of the loan amount. Paying a point typically reduces the interest rate by about 0.125%. The exact reduction may vary depending on the loan and the lender, but that's a good ballpark estimate.
As a result, paying one point on a $100,000 loan with a 4.25% annual percentage rate (APR) will cost you $1,000 at closing, but your loan rate might drop from 4.25% to 4.125% APR. This would reduce your principal and interest payment from about $492 a month to about $485.1
You might opt to pay points on your mortgage if you have plenty of cash on hand but need to reduce your monthly payment to a level that's within your income. Before you reach that decision, make sure you have enough cash to cover the basics of your loan—the down payment and closing costs—along with enough cash to get you through the initial costs of home ownership, which could include everything from paint and landscaping supplies to new furniture, utility deposits and moving costs.
Key considerations for paying points
If you're thinking about paying points to help lower your mortgage interest rate, here are a few tips to keep in mind.
- Know your break-even point – Paying points can save you money in the long run, but only if you stay in your house long enough. Ask your lender to figure the payments on a full-rate mortgage and on a mortgage with points to find your break-even point.
- Understand tax deductions – Points are considered prepaid mortgage interest, so they may be deductible in the year you pay them or in the following years. Check with a tax professional for details.
- Document gifts – It may be okay for someone to give you cash to pay for points or for a seller to pay them as an inducement. Lenders will tell you what documentation they need to cover those cases.
Keep it up. You're getting smarter about home buying.
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