Questions About Mortgage Points
16 February 2004, Revised February 22, 2005, November 29, 2006, November
15, 2008
Points are an upfront charge by the lender that is part of the price of a mortgage. Points are expressed as a percent of the loan amount, with 3 points being 3%. On a $100,000 loan, 3 points means a cash payment of $3,000. Points are part of the cost of credit to the borrower.
Points can be negative, in which case they are "rebates" from the lender to the borrower. Rebates can be used by borrowers to defray other settlement costs.
Low rates come with positive points, high rates come with rebates. Lenders offer borrowers a range of interest rate/point combinations, leaving it to borrowers to select the combinations best suited to their needs.
Low rate/high point loans are for borrowers who can meet the cash requirement, and either have a long time horizon or want to reduce their monthly mortgage payment. High rate/low point combinations are for borrowers who don't expect to be in their house very long, or who are short of cash. For greater specificity, calculate the break-even periods using my calculator 11a, Break-Even Period on Paying Points on Fixed-Rate Mortgages, and 11b, Break-Even Period on Paying Points on Adjustable-Rate Mortgages.
Yes, but it reduces the benefit to the borrower unless the borrower is in a low tax bracket and can earn a high return on his cash. You should never finance points if it pushes the loan amount up to a level that triggers a larger mortgage insurance premium. See Can Mortgage Points Be Financed?
On a purchase transaction, points paid in cash are fully deductible in the year the loan is closed. If the points are financed, they remain deductible if the cash contribution by the borrower for down payment and other costs exceeds the points. On a refinance, points paid in cash are deductible but the deduction must be spread evenly over the term. If the loan is paid off, the unused portion can be taken in the payoff year. If financed points are not deductible as points, they are deductible as interest. See Are Mortgage Points Deductible?
Starting with the base interest rate, which is the rate closest to zero points, expect to pay about 1.5 points on a 30-year fixed-rate mortgage. For example, if the lender quotes 6% at zero points and you want to reduce the rate to 5.75%, it will cost about 1.5 points. To reduce the rate by .375%, .5% or .625%, expect to pay about 2.125, 2.75 and 3.25 points, respectively.
Similarly, the following rate increases are required to produce the indicated rebates: .125%/.625 points; .25%/1.125 points; .375%/1.625 points; .5%/2.125 points; .625%/2.625 points; and .75%/3 points. For example, if you want a rebate of 2.125 points, expect to pay a rate about .5% higher.
On 15-year loans, all the points shown above would be about .375 points lower.
These numbers are averages based on price sheets of 10 lenders in Feb, 2005, and they are anything but firm. The amount of variability from lender to lender is surprisingly large. For example, while the average price to reduce the rate by .25% was about 1.5 points, two lenders charged only 1 point and one lender asked for 1.875 points. Similarly, while the average rebate obtainable for a .375% rate increase was about 1.625 points, one lender offered 2.112 points while another offered only 1 point.
For some figures as of August, 2007, see How Many Points for a 1/4% Break in Mortgage Rate?
Paying points to reduce the rate usually yields a high rate of return on investment if the borrower has the loan for 4 years or longer. For a more detailed analysis that covers different types of mortgages, see Is It True That Paying Mortgage Points Doesn't Pay?
Before you shop, decide what you want to do about points. If you want to pay points to reduce the rate, you shop rate based on a specified number of points. This has the added advantage of letting loan officers know that you know what you are doing.
If you want a rebate, the best strategy is to shop rate on a no-cost loan, which means a rebate high enough to cover all settlement costs except escrows and interim interest. This has the added advantage of protecting you against getting whacked with additional settlement costs at closing. See No-Cost Mortgages.
Selecting a loan provider while the rate/point combination is undecided is a bad mistake. Because of the wide variability in pricing points, the lender offering the lowest points at one rate is not necessarily the same as the lender offering the lowest points at a different rate.
Furthermore, once you are too far along in the process to back out, the price in points to lower the rate, or the price in rate to increase the rebate, may be "off the sheet". Meaning that the loan officer may take advantage of the opportunity to make a few extra dollars by giving you a worse deal than the one shown on his price sheet.
Don’t let this happen to you.
What Are Points?
Points are an upfront charge by the lender that is part of the price of a mortgage. Points are expressed as a percent of the loan amount, with 3 points being 3%. On a $100,000 loan, 3 points means a cash payment of $3,000. Points are part of the cost of credit to the borrower.
Points can be negative, in which case they are "rebates" from the lender to the borrower. Rebates can be used by borrowers to defray other settlement costs.
Low rates come with positive points, high rates come with rebates. Lenders offer borrowers a range of interest rate/point combinations, leaving it to borrowers to select the combinations best suited to their needs.
How Should Borrowers Make the Decision to Pay Points or Not?
Low rate/high point loans are for borrowers who can meet the cash requirement, and either have a long time horizon or want to reduce their monthly mortgage payment. High rate/low point combinations are for borrowers who don't expect to be in their house very long, or who are short of cash. For greater specificity, calculate the break-even periods using my calculator 11a, Break-Even Period on Paying Points on Fixed-Rate Mortgages, and 11b, Break-Even Period on Paying Points on Adjustable-Rate Mortgages.
Can Points Be Financed?
Yes, but it reduces the benefit to the borrower unless the borrower is in a low tax bracket and can earn a high return on his cash. You should never finance points if it pushes the loan amount up to a level that triggers a larger mortgage insurance premium. See Can Mortgage Points Be Financed?
Are Points Tax-Deductible?
On a purchase transaction, points paid in cash are fully deductible in the year the loan is closed. If the points are financed, they remain deductible if the cash contribution by the borrower for down payment and other costs exceeds the points. On a refinance, points paid in cash are deductible but the deduction must be spread evenly over the term. If the loan is paid off, the unused portion can be taken in the payoff year. If financed points are not deductible as points, they are deductible as interest. See Are Mortgage Points Deductible?
How Many Points Must I Pay to Reduce the Interest Rate by ¼%?
Starting with the base interest rate, which is the rate closest to zero points, expect to pay about 1.5 points on a 30-year fixed-rate mortgage. For example, if the lender quotes 6% at zero points and you want to reduce the rate to 5.75%, it will cost about 1.5 points. To reduce the rate by .375%, .5% or .625%, expect to pay about 2.125, 2.75 and 3.25 points, respectively.
Similarly, the following rate increases are required to produce the indicated rebates: .125%/.625 points; .25%/1.125 points; .375%/1.625 points; .5%/2.125 points; .625%/2.625 points; and .75%/3 points. For example, if you want a rebate of 2.125 points, expect to pay a rate about .5% higher.
On 15-year loans, all the points shown above would be about .375 points lower.
These numbers are averages based on price sheets of 10 lenders in Feb, 2005, and they are anything but firm. The amount of variability from lender to lender is surprisingly large. For example, while the average price to reduce the rate by .25% was about 1.5 points, two lenders charged only 1 point and one lender asked for 1.875 points. Similarly, while the average rebate obtainable for a .375% rate increase was about 1.625 points, one lender offered 2.112 points while another offered only 1 point.
For some figures as of August, 2007, see How Many Points for a 1/4% Break in Mortgage Rate?
Are Points a Good Investment?
Paying points to reduce the rate usually yields a high rate of return on investment if the borrower has the loan for 4 years or longer. For a more detailed analysis that covers different types of mortgages, see Is It True That Paying Mortgage Points Doesn't Pay?
How Should Points Affect the Way I Shop For a Mortgage?
Before you shop, decide what you want to do about points. If you want to pay points to reduce the rate, you shop rate based on a specified number of points. This has the added advantage of letting loan officers know that you know what you are doing.
If you want a rebate, the best strategy is to shop rate on a no-cost loan, which means a rebate high enough to cover all settlement costs except escrows and interim interest. This has the added advantage of protecting you against getting whacked with additional settlement costs at closing. See No-Cost Mortgages.
Selecting a loan provider while the rate/point combination is undecided is a bad mistake. Because of the wide variability in pricing points, the lender offering the lowest points at one rate is not necessarily the same as the lender offering the lowest points at a different rate.
Furthermore, once you are too far along in the process to back out, the price in points to lower the rate, or the price in rate to increase the rebate, may be "off the sheet". Meaning that the loan officer may take advantage of the opportunity to make a few extra dollars by giving you a worse deal than the one shown on his price sheet.
Don’t let this happen to you.