How Much is 2 Points on a Loan? A Complete Guide

It’s a big financial choice to take out a loan to buy something big like a house or car. The best interest rate is one that you can get, but many lenders let you “buy down” the rate by paying points up front. But how much do points really save you, and are they worth the money?

This complete guide will explain what points are and how they work with loans. It will also look at how much 2 points on a loan might save you.

What Are Points on a Loan?

Points are fees you pay to a lender to lower the interest rate on a loan. They are also called discount points or mortgage points. One point is equal to one percent of the total loan amount.

As an example, if you borrow $200,000 for a mortgage, each point would cost $2,000, which is 1% of $200,000. When you pay points, the interest rate goes down, which means your monthly payments go down too.

Points are most commonly associated with mortgages, but can also be used with other types of loans like auto loans. The main benefit of paying points is getting a lower rate, which saves money over the full term of the loan.

How Do Points Work?

Let’s look at an example to understand how paying points can affect mortgage rates and payments:

• Loan amount: $200,000
• Loan term: 30 years
• Interest rate with 0 points: 5.5%
• Interest rate with 2 points: 5.0%

In this case, each point costs 1% of $200,000, or $2,000 So 2 points would cost $4,000 ($2,000 x 2). By paying $4,000 upfront, the rate is reduced by 05% for the full 30 year term.

Here’s how the monthly principal & interest payments compare:

• Payment with 0 points at 5.5%: $1,135
• Payment with 2 points at 5.0%: $1,073

Buying down the rate by paying 2 points saves $62 per month ($1,135 – $1,073). Over 30 years, that adds up to over $22,000 in interest savings.

However, it takes time for the upfront cost of the points to pay off. In this example, it would take about 5 years to break even ($4,000 paid upfront divided by $62 monthly savings).

How Much Do 2 Points Lower Interest Rates?

In general, each point typically reduces mortgage rates by 0.25%.

So, buying two points would lower your interest rate by 0.5%. However, the exact rate reduction depends on the lender.

Some lenders may discount the rate further per point, while others provide less of a reduction. It’s important to ask your specific lender how much two points would save on your loan.

For other types of loans, the rate reduction per point varies:

• Auto loans: 0.25% per point
• Personal loans: 0.15% per point
• Student loans: 0.25% per point

Again, these are general guidelines – the actual rate reduction with points depends on the lender.

Should You Pay for Points?

Whether paying for points makes sense depends on a few key factors:

1. How much are points costing? Calculate 1-2% of your total loan amount to estimate the upfront cost. Each point costs 1% of the loan.

2. How much do they reduce rates? Ask your lender exactly how much they’ll discount the rate per point.

3. How long is the loan term? Points pay off over time, so longer loans like 30 year mortgages benefit the most.

4. How long will you keep the loan? To break even, you’ll need to keep the loan at least as long as the points take to pay off.

5. What’s your budget? Can you afford to pay the points upfront or finance them into the loan?

Crunching the numbers for your specific loan scenario will determine if points make sense financially. Generally, paying points is best for stable borrowers who plan to keep a loan long term.

Pros and Cons of Paying Points

Here are some key advantages and disadvantages of paying points on a loan:

Pros

• Lower interest rate and monthly payments
• Interest savings over the loan term
• Tax deductions – points are deductible in the year they are paid

Cons

• Large upfront cost
• Takes time to break even (often years)
• Lost savings if refinancing or selling home before break even

Alternatives to Paying Points

Some options besides buying down rates with points include:

• Comparing lender rates – Shop around for the best no-points rate.

• Negotiating rates – Ask if lenders can lower rates further without points.

• Paying down principal – Making extra payments reduces interest costs.

• Adding co-signer – Having a co-signer with better credit can improve rates.

• Improving credit score – Rates are tied to credit scores, so boosting yours may lower rates.

The Bottom Line

Paying points allows borrowers to buy down interest rates on loans, saving money each month and over the full repayment period. Specifically, two points on a loan will generally reduce rates by around 0.5%.

To determine if points are worth paying, look at the upfront cost, monthly savings, loan length, and how long you plan to keep the loan. For buyers who can afford them and will keep a mortgage long term, points can provide substantial interest savings. But shop around and compare options, as points don’t make sense for every borrower’s situation.