What Are Mortgage Points And How Do They Work?

Mortgage points are a fee you pay your lender upfront to get a lower interest rate on your loan. A lower interest rate can reduce your monthly payment — and reduces the total amount of interest you’ll pay over the life of your mortgage. This practice is often referred to as “buying down the interest rate” or a “buydown.” Mortgage points are sometimes called discount points.

How do mortgage points work?

Each mortgage point typically lowers your loan’s interest rate by 0.25 percentage points for the life of the loan. In exchange for this lower rate, you’ll usually pay your lender 1 percent of the mortgage amount.

Your lender may value points differently. If you’re thinking about buying points, ask your loan officer for specifics.

You can buy more than one point, and even fractions of a point. A half-point on a $400,000 mortgage would typically cost $2,000 and lower the mortgage rate by about 0.125 percent.

You’ll pay for the points at closing. They’re called “prepaid interest” on the loan estimate, which you’ll receive within three business days of applying for a mortgage, and the closing disclosure, which you’ll receive at least three business days before closing the loan.

When you receive your mortgage loan offer, first clarify whether the stated quote requires you to pay points. If you can’t get that rate without paying points, you might want to ask for another quote that doesn’t require them. You can then compare the differences in rates.

How much can you save by paying mortgage points?

If you can afford to buy discount points on top of your down payment and closing costs, you’ll lower your monthly mortgage payments and could save money overall. The key is staying in the home long enough to recoup the prepaid interest. If, after only a few years, you sell the home, refinance the mortgage or pay it off, buying discount points could mean you lose money.

Here’s an example of how discount points can reduce costs on a $400,000, 30-year, fixed-rate mortgage:

In this example, by buying two points for $8,000 upfront, the borrower lowered their monthly payment by $133 and saved $47,858 in interest over the life of the loan. However, to save that full amount, the borrower would have to live in the home for the full, 30-year loan term and never refinance.

How to calculate your break-even point

To calculate the point at which you’d recover your outlay on the prepaid interest, divide the cost of the mortgage points by the amount the reduced rate saves you each month. Here’s an example:

In this case, the borrower would have to stay in the home for about 30 months, or two-and-a-half years, to recover the cost of the points.

You can use Bankrate’s mortgage points calculator and amortization calculator to figure out whether buying mortgage points will save you money.

Pros and cons of mortgage points

Mortgage points offer benefits and drawbacks:

Pros

• Lower monthly payments and less interest paid overall
• Potentially tax-deductible

Cons

• Costs money upfront
• Won’t save you money if you sell or refinance before the break-even point

Should you buy down your interest rate with points?

Right now, with interest rates higher than they have been in recent years, the idea of buying mortgage points might seem more appealing. However, because home values are also elevated, you might find that your break-even point is five or more years in the future. The longer it takes to recoup the cost of your points, the more carefully you should think about buying them — especially if rates are also trending downward (lower rates might prompt you to refinance).

For some, that exercise might not be worth their time or the relatively small amount of monthly savings.

“I’m ambivalent about paying points. It strikes me as a lot of extra analysis without a big reward,” says Jeff Ostrowski, writer and housing market analyst for Bankrate. “But, if it’s very important to you to lower the rate over the life of your loan, and you have cash on hand to make it work, go ahead. Just make sure you’ll keep the mortgage long enough to recoup the upfront costs.”

When is it a good idea to buy mortgage points?

Buying mortgage points is more likely to make sense in specific situations. For example:

• If you plan to be in the home for a long time: Because buying mortgage points reduces the rate for the life of the loan, every dollar you spend on points goes further the longer you pay that mortgage. If you plan to be in the house for years to come, the amount you’ll save is likely to make the upfront cost worth it.
• If you don’t plan to refinance any time soon: Generally, it’s not worth paying for points if you plan to refinance to a different rate before the break-even point.

If you’re not sure whether you should buy down your rate with points, do the math. It might make more financial sense to use the money you’d spend on points to make a bigger down payment, which would reduce the amount you need to borrow.

Discount points vs. origination points

Don’t confuse mortgage points that lower your interest rate with origination points. An origination point doesn’t affect your mortgage’s interest rate; rather, it’s a required fee the lender charges to create, process and underwrite the loan.

One origination point typically equals 1 percent of the total mortgage. Similar to discount points, you’ll pay origination points as part of your closing costs.

Not all lenders charge origination points. Some lenders allow borrowers to get a loan with no or reduced closing costs, but that often means you’ll pay a higher interest rate or other fees.

FAQ

• How are mortgage points factored into APRs?
  

  The annual percentage rate, or APR, you see on a lender’s website or through a third party might or might not include points. If a rate seems surprisingly low, it’s likely because points — which you may not want to buy — are already factored in. Be sure to read the fine print.

• Are mortgage points tax-deductible?
  

  If you itemize your tax deductions, you can deduct mortgage points as part of the mortgage interest deduction. Mortgage interest and mortgage points are tax-deductible on up to $750,000 of mortgage debt for homeowners who bought property after Dec. 15, 2017, or up to $1 million for those who purchased before that date. Origination points are not tax-deductible.

• How do mortgage points work with adjustable-rate mortgages (ARMs)?
  

  With an ARM, buying mortgage points only lowers the rate on the initial fixed-rate period of the loan, usually three, five, seven or 10 years. Because of this, it’s not very common to buy points on an ARM.