What are Mortgage Points and Why Should You Care?

Mortgage points can be a confusing topic. 

Some people say you should pay for them. Some say you shouldn't.  Some people don't even really know what they are. So, to clear up the confusion, we went to an expert. Mortgage Specialist Jason Hellman from Dundee Banking spoke with us recently about the Great Points Debate. His answers are fantastic and informative. Enjoy!

When talking about mortgages, what does the word “points” mean?

“Points” is mortgage industry jargon for pre-paid interest charged as a fee at closing. Historically, “one point” was charged by lenders to close a loan.  One point is one percent of the loan amount.  This practice has changed over time.  In most markets, the norm has transitioned from one-point to no-points as a standard.

"'Points' is mortgage industry jargon for
pre-paid interest charged as a fee at closing."

In your opinion, is it worth it to buy points? Why or why not?

Points vs no points…It’s not my opinion that matters.  The only time to pay points at closing is if you expect to remain in the home, and in the mortgage as it was closed, for long enough to recover the up front expense of paying points.  If you expect to move up, move down, relocate, or refinance for any reason, its likely paying points at closing will not be a good investment.

When I consult with clients about paying points (or not) at closing, we calculate the cost of the points, divided by the monthly savings.  This gives us the number of months to a “break even” date.  Any time before the break even date and the up front fee is larger than the cumulative monthly savings (e.g., poor investment).  Any time after the break even date and the cumulative monthly savings is greater than the up front charge (e.g., good investment).

 "If you expect to move up, move down, relocate, or refinance for any reason, it's likely paying points at closing will not be a good investment."

Of course, many buyers simply don’t know what the future holds.  In these cases, I generally use a 5-year benchmark.  Is it likely for you to have this loan in 5-years?  Ironically, the interest rate market routinely gives us a 50-70-month break even point.  Regardless of the loan amount, or number of points paid, the monthly savings generally “pay back” the up front charge in 50-70 months – or about 5-years.

In which situation would it benefit a homeowner to buy a point or points?

If a buyer expects to enjoy the home beyond the break even date, without the need for a refinance transaction, then they should consider paying points.

From time to time I will deviate from the simple “break even” analysis described above and recommend a client pays points.

Sometimes buyers have already negotiated “seller-paid closing costs” that are in excess of our normal, no points, closing costs.  If this happens, we recommend spending the seller’s credit by paying points to lower the rate.  The alternative would be to leave a portion of the seller credit unused.  This is really just like paying more than you agreed for your new home.  I avoid not using the entire credit every time.

There are some other cases when I recommend paying points regardless of the “break even” analysis.  Some buyers enjoy a family gift to help them buy their home.  Often the donor wants to “pay the closing costs”.  In these cases, sometimes it is possible to use their generosity to help lower their loved one's monthly payment.

The last scenario when I recommend paying points involves buyers that may have some flexibility with their assets, but limited flexibility with their monthly budget.  Sometimes we use pre-paid interest as a way to lower the monthly payment to make the new home affordable.  This often involves “fixed income” scenarios like social security, disability income, or income from a trust.

What would you suggest a homeowner spend their money on if they decided on not buying points?

If we decide it’s most prudent not to pay points at closing and there are spare assets that could be deployed for the home, I recommend a strong savings account.  To be frank, your new home is expensive and often comes with a few surprises.  Buyers need strong reserves in case of emergency and also to make their new house their home.

After the moving expenses, I caution buyers about the costs of cleaning supplies, vacuums, lawn mowers, bath mats, bath towels and utility start-ups.  It’s also fairly common for a home that sees a change in typical use to experience some unexpected repairs or maintenance.

Your new home is expensive and often comes with a few surprises.
Buyers need strong reserves in case of emergency and also
to make their new house their home.

For example, if an aging widow moves out of a home and a young family of six moves in, the plumbing and drains may not accommodate the new heavy use at first.  The drains may need cleaned out, the HVAC may need serviced, the gutters cleaned, the landscape re-graded around the foundation…I want my buyers to be equipped for surprises so they can enjoy their new home.