What Are Points? Should I Pay Points?

Question
My loan officer on my mortgage asked if I wanted to pay Points. So I’m asking, What Are Points?”
Answer
Ah Points. Let’s start with why your loan officer is asking this question. Most likely, your loan officer makes their money by commission based on Points they charge and by the Yield Spread Premium or Service Release Premium they can make on the interest rate they sell you. See: Don’t Get Fooled By The Yield Spread Premium article for more on Yield Spread Premiums and Service Release Premiums.

What Are Points?
A Point is 1% of your mortgage loan amount. If you are getting a $200,000 mortgage then 1 Point is $2,000. If you were going to pay “Points” say 2 Points then that is 2% of $200k for $4,000.

Points Are Paid Either Out Of Your Pocket Or By A Home Seller
If you agree to pay Points then you will have to pay this money out of your pocket at the time that you get your mortgage. If you are buying a home and you were able to negotiate some closing cost assistance, or a credit from the seller, then some of this money could be used to cover any Points that you agreed to pay for the mortgage.

Should I Pay Points?
To answer this question I need to point out two things: how Points impact your interest rate; and how long does it take to recoup the money paid in Points.
First the Interest Rate: Under normal circumstances and if your loan officer being honest with you, then paying Points should get you a lower interest rate than not paying Points. In the above example, let’s pretend that your loan officer quoted you 6.75% with 1 Point. To find out how much your interest rate would be if you were not going to pay Points you should ask your loan officer “what would my interest rate be if I didn’t pay points?” Your loan officer ought to give you a quote somewhere near 7% as every .25% change in a mortgage interest rate is approximately equal to 1 Point. In the opposite, you could ask your loan officer what your interest rate would be if you paid 2 Points. Their answer ought to be around 6.5%.
Next, Recouping your Points: Without going into a lot of math, on average it takes about 4 years to recoup the money that is paid for Points. How you figure this out is to go to any mortgage calculator, you can use them on GetPreQualified.com by going to our Finance Calculators and comparing the difference in mortgage payments of paying Points and not paying Points.
With the impact of paying Points on your interest rate discussed and with how long it takes to recoup your Points discussed you now have several questions to answer for yourself to determine whether you want to pay Points or not.

Is the mortgage payment without paying Points acceptable and within my budget or not? If it is then you may not want to pay any Points.

Do I have the money in the bank to pay Points? If you don’t, then you can’t pay Points unless you can get some closing cost assistance from the seller if you are buying a home. If you do, then you have to decide whether you want to part with your money for a lower interest rate.

How long am I going to stay in this home? Or how long am I going to keep this mortgage before I refinance? If you can clearly see that you are either going to be in the home for longer than 5 years, or are not going to refinance within the first 5 years of getting your mortgage then you may consider paying Points.

None of these questions are necessarily answers on their own for whether you should pay Points or not. Rather, you need to weigh the payment with and without Points against your budget, your bank account, and your time with the mortgage. When you put all of these together you should be able to see what is best for you: to pay Points or to not pay Points.
Just as an aside: see our article called What Is a No Cost Mortgage – Can I Really Get A Mortgage For Free or Are No Cost Mortgages A Real Deal for more in depth discussion of paying Points and deceptive marketing practices used by mortgage companies to get your business.