Mortgage Q&A: “What are mortgage points?”
The mortgage process can be pretty stressful and hard to make sense of at times, what with all the crazy terminology and stacks of paperwork.
Further complicating matters is the fact that banks and lenders do things differently. Some charge so-called loan application fees while others ask that you pay points. Then there are those that tack on lender fees and points.
While shopping for a home loan, you’ll likely hear the term “mortgage point” on more than one occasion.
Be sure to pay special attention to how many points are being charged (if any), as it will greatly affect the true cost of your loan.
How Much Is a Mortgage Point?
Wondering how mortgage points are calculated? Don’t worry, it’s actually really easy. You don’t even need a mortgage calculator! Or a so-called mortgage points calculator, whatever that is…
When it comes down to it, a mortgage point is just a fancy way of saying a percentage point of the loan amount.
Essentially, when a mortgage broker or mortgage lender says they’re charging you one point, they simply mean 1% of your loan amount, whatever that might be.
How do you calculate points on a mortgage?
So if your loan amount is $400,000, one mortgage point would be equal to $4,000. If they decide to charge two points, the cost would be $8,000. And so on.
If your loan amount is $100,000, it’s simply $1,000 per point. It’s a really easy calculation. Just multiply the number of points (or fraction thereof) times the loan amount.
If it’s one point, take a calculator and input .01 multiplied by the loan amount. If it’s 1.5 points, input .015 multiplied by the loan amount.
Using $300,000 as the loan amount in the above equation, we’d come up with a cost of $3,000 and $4,500, respectively.
Clearly a mortgage point can vary greatly based on the loan amount, so not all points are created equal folks.
Tip: The larger your loan amount, the more expensive mortgage points become, so points may be more plentiful on smaller mortgages if they’re being used for commission.
There Are Two Types of Mortgage Points
There are two types of mortgage points you could be charged when obtaining a mortgage.
A mortgage broker or bank may charge mortgage points simply for originating your loan, known as the loan origination fee. This fee may be in addition to other lender costs, or a lump sum that covers all of their costs and commission.
For example, you might be charged one mortgage point plus a loan application and processing fee, or simply charged two mortgage points and no other lender fees.
Additionally, you also have the choice to pay mortgage discount points, which are a form of prepaid interest paid at closing in exchange for a lower interest rate and cheaper monthly payments.
They are used to buy down your interest rate, assuming you want a lower rate than what is being offered. Generally, you should only pay these types of points if you plan to hold the loan long enough to recoup the upfront costs via the lower rate.
You can use a mortgage calculator to determine how many monthly mortgage payments it’ll take for buying points to make sense. This is essentially how long you need to keep the home loan to come out ahead.
It would probably make more sense to pay mortgage points on a 30-year fixed as opposed to an adjustable-rate mortgage, seeing that you could benefit for many more months, though both situations could make sense depending on the price.
These types of points are tax deductible, seeing that they are straight-up interest. And that tax benefit should be factored into the equation
*The loan origination fee may also be tax deductible if it’s expressed as a percentage of the loan amount and certain other IRS conditions are met.
If you aren’t being charged mortgage points directly (no cost refi), it doesn’t necessarily mean you’re getting a better deal. All it means is that the mortgage broker or lender is charging you on the back-end of the deal. There is no free lunch.
In other words, the lender is simply offering you an interest rate that exceeds the par rate, or market rate you would typically qualify for.
So if your particular loan scenario had a par rate of say 6%, but the mortgage broker or bank could earn two mortgage points on the “back” if he/she convinced you to take a rate of 6.75%, that would be their yield-spread-premium (YSP), or commission.
Banks can offer mortgages without points as well because of the “service release premium” (their form of YSP), which is a fee they earn when they sell their loans on the secondary market.
Sure, you might not pay any mortgage points out-of-pocket, but you will pay the price by agreeing to a higher mortgage rate than necessary, which equates to a lot more interest paid throughout the life of the loan.
Before YSP was outlawed, this was a common way for a broker to earn a commission without charging the borrower directly. Nowadays, brokers can still be compensated by lenders, but not for offering you a higher mortgage rate than what you qualify for.
How do negative points work on a mortgage?
If points are involved and you are offered a higher rate, the mortgage points act as a lender credit toward your closing costs. These are known as “negative points” because they actually raise your interest rate.
Now you might be wondering why on earth you would accept a higher rate than what you qualify for?
Well, the trade-off is that you don’t have to pay for your closing costs out-of-pocket. The money generated from the higher interest rate will cover those fees. Of course, your monthly mortgage payment will be higher as a result. How much higher depends on the size of your loan amount and the points involved.
This works in the exact opposite way as traditional mortgage points in that you get a higher rate, but instead of paying for it, the lender gives you money to pay for your fees.
Both methods can work for a borrower in a given situation. The positive points are good for those looking to lower their mortgage rate even more, whereas the negative points are good for a homeowner short on cash who doesn’t want to spend it all at closing.
Let’s look at some examples of mortgage points in action, shall we:
Say you’ve got a $100,000 loan amount and you’re using a broker. If the broker is being paid two mortgage points from the lender at par to the borrower, it will show up as a $2,000 origination charge (line 801) and a $2,000 credit (line 802) on the HUD-1 settlement statement. It is awash because you don’t pay the points, the lender does. However, a higher mortgage rate is built in as a result.
Now let’s assume you’re just paying two points out of your own pocket to compensate the broker. It would simply show up as a $2,000 origination charge, with no credit or charge for points, since the rate itself doesn’t involve any points.
You may also see nothing in the way of points and instead an administration fee or similar vaguely named charge. This could be the lender’s commission bundled up into one charge that covers things like underwriting, processing, and so on. It could represent a certain percentage of the loan amount, but have nothing to do with raising or lowering your rate.
Regardless of the number of mortgage points you’re ultimately charged, you’ll be able to see all the figures by reviewing the HUD-1 (lines 801-803), which details both loan origination fees and discount points and the total cost combined.
*These fees will now show up on the Loan Estimate (LE) and Closing Disclosure (CD) under the Loan Costs section.
Mortgage Points Cost Chart
Above is a handy little chart I made that displays the cost of mortgage points for different loans amounts, ranging from $100,000 to $1 million.
As you can see, a mortgage point is only equal to $1,000 at the $100,000 loan amount level. So you might be charged several points if you’ve got a smaller loan amount (they need to make money somehow).
At $1 million, you’re looking at $10,000 for just one mortgage point. And you wonder why loan officers want to originate the largest loans possible…
Generally, it’s the same amount of work for a much bigger payday if they can get their hands on the super jumbo loans out there.
Be sure to compare the cost of the loan with and without mortgage points included, across different loan programs such as conventional offerings and FHA loans. Also remember that points can be paid out-of-pocket or priced into the interest rate of the loan.
Also note that not every bank and broker charges mortgage points, so if you take the time to shop around, you may be able to avoid points entirely while securing the lowest mortgage rate possible.
Read more: Are mortgage points worth paying?