18 April 2006, Revised November 15, 2008
Points are fees the borrower pays the lender at the time the loan is
closed, expressed as a percent of the loan. On a $100,000 loan, 2 points
means a payment of $2,000. If points are negative, it is called a
“rebate”, which the lender pays. For background information about
points, see
Questions About Points.
Points are traded off against the interest rate. For example, I took the
following schedule for 30-year fixed-rate mortgages (FRMs) from a
lender's price sheet on November 14, 2008.
| Interest Rate |
Points |
| 5.375% |
2.83 |
| 5.5 |
2.20 |
| 5.625 |
1.72 |
| 5.75 |
1.00 |
| 5.875 |
0.37 |
| 6 |
0.00 |
| 6.125 |
-0.42 |
| 6.25 |
-0.60 |
| 6.375 |
-0.76 |
| 6.625 |
-1.18 |
Paying points is an investment. The return is the lower payment and
faster balance reduction that results from the lower rate. The return is
higher the longer you have the mortgage.
Assume you were choosing from the schedule above and elected to pay 1
point to reduce the rate from 6% to 5.75%. If you have the mortgage 4
years or less, you earn nothing on your investment. Over 5 years,
however, you earn 7.45% and over 10 years you earn 17.56%. I calculated
these returns, as you can, using calculator 11c
Mortgage Points Calculator: Rate of Return on FRMs. A companion
calculator, 11d,
Mortgage Points Calculator: Rate of Return on ARMs, does the same for
ARMs.
Negative points are payments made by the lender to you for paying a
higher rate. For example, the lender shown above will pay you 1.18
points for accepting a 6.625% rate rather than 6%. You can use the
payments to defray settlement costs.
Where points that you pay yield a higher return the longer you have the
mortgage, points that you receive cost you more the longer you have the
mortgage. In the example above, you will be paying the lender 5% on the
rebate for the 1.18 point rebate over 2 years, 27% over 3 years, and 42%
over 10 years.
I have calculated returns from similar schedules covering a number of
lenders and different types of mortgages. In general, paying points is a
good investment if you hold the mortgage 4 years or longer, whereas
negative points are very costly unless you are out within 2 years.
Adjustable rate mortgages generally provide a higher rate of return on
points than FRMs. See
Is It True That Paying Mortgage Points Doesn't Pay?
I also found that differences between lenders are large. One lender
offered better deals buying down the rate on a 15-year FRM than on a 30,
while another lender offered a better deal on a 30. This is why it is a
good idea to know exactly how many points you want to pay (or receive)
before you shop for a mortgage.
Before you shop for a mortgage, 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.