Mortgage Points: What They Are and How They Work

Key Takeaways

Mortgage points are helpful upfront fees used to lower your mortgage interest rate. One point typically costs you 1% of your loan amount. They can help you save money by lowering both your monthly payments and your total loan costs.
There are two types of mortgage points: discount points, which lower the interest rate, and origination points, which cover lender fees. Costs and benefits are lender specific.
Buying mortgage points can save money over the long term, especially for homeowners with stable finances and plans to stay in their home for many years.
Second, high upfront costs make buying points a major barrier. Moreover, in cases where a borrower sells or refinances early, the benefits could be outweighed, particularly for borrowers with shorter-term loans or less stable housing trajectories.
Estimating your breakeven point is very important. It allows you to determine whether the benefit of paying less each month will cover the up-front expense of buying points.
Alternatives to buying points include negotiating a better interest rate, making a larger down payment, or selecting a shorter loan term to reduce overall costs.

With a little understanding, you can make wiser decisions about this and other aspects of your home loan.

What are mortgage points?

Mortgage points, or discount points, allow you to buy down your interest rate. Each point typically costs 1% of your loan amount and can lower your interest rate by a fraction of a percent.

The longer you remain in your home, the more money it makes sense to invest. This option gives you the opportunity to offset those upfront costs.

Most importantly, consider how the benefits outweigh your short-term budget and long-term goals. Knowing when it makes sense to buy points is an important part of mortgage shopping.

That’s going to depend on your loan size, monthly payment and how long you’re going to be in your home.

What Are Mortgage Points

Definition of Mortgage Points

Mortgage points are essentially fees paid upfront in order to buy down your interest rate. Each mortgage point is equal to 1% of the loan amount. So, on a $300,000 mortgage, one point costs $3,000.

When you buy points, you lock in a lower interest rate, saving you money with lower monthly mortgage payments. For example, purchasing one point could reduce a 6.5% rate to 6.25%, which will save you money over the life of the loan.

Perhaps the most significant effect of this is seen in your monthly payments, which are greatly reduced. A lower rate means lower monthly payments, which goes a long way toward long-term affordability.

Types of Mortgage Points

There are two main types of mortgage points: discount points and origination points.

Discount points are used to buy down your loan’s interest rate. As an example, purchasing four points could reduce your rate by 1%.

Origination points, on the other hand, are a fee that lenders charge to process the loan. Costs for points can range widely based on lenders’ practices.

Note that you don’t need to purchase whole points. You can frequently find partial points available for purchase, allowing you greater flexibility in your budget and long-term objectives.

How Mortgage Points Work

Mortgage points function by exchanging an upfront expense for interest rate decreases. If you purchase one point on a $200,000 loan you would pay $2,000 in points upfront.

Depending on your loan terms, this could save you $117 per month. With each passing month, your savings make up for the cost of the points.

This is particularly advisable if you intend to live in your home long-term. Generally, each discount point reduces the rate by 0.25%.

For instance, if you purchase two points, your interest rate could decrease from 6.5% to 6%. The longer you remain in the house, the more you save.

Benefits of Buying Mortgage Points

Lowering Monthly Payments

One of the greatest advantages to purchasing mortgage points is the opportunity to reduce your monthly mortgage payment. Reducing your mortgage rate, even by just a few basis points, can save you thousands of dollars. Marvel as your monthly payments plummet dramatically!

That’s why, for instance, buying one point—which generally costs 1% of your loan amount—would reduce your rate by 0.25%. On a $300,000 loan, this can translate into saving around $40 to $50 per month on your mortgage payment. Those savings can turn into thousands of dollars over the years, making your budget more comfortable.

For households with more stretched finances, this would offer a significant financial relief. Reducing monthly payments could help make homeownership more achievable for lower-income borrowers, particularly while balancing other rising costs.

It’s important to know how much you’ll save each month. It allows you to save for other long-term financial priorities, like paying off college or other debt, or creating an emergency fund.

Saving on Long-Term Interest Costs

If you have the cash to buy mortgage discount points upfront, it could save you thousands of dollars over the life of your mortgage loan. Even just a 0.25% reduction in your interest rate can lead to significant interest savings over a 30-year mortgage. It’s a straightforward strategy that can save you thousands!

For example, suppose you’re securing a $300,000 mortgage amount at 6% interest. Without buying points, you would end up paying more than $347,000 just in interest. By purchasing enough mortgage points to reduce your rate to 5.5%, your total interest drops to about $313,000. This smart decision saves you $34,000!

If you plan to stay in your new home for over five years, this upfront expense transforms into a wise investment. Your finances will benefit from the money saved in the long run!

It’s a dual advantage. Not only do you save on your monthly payment, but the overall long-term savings provide you with double the benefit. The key to this calculation is comparing scenarios with and without points to truly appreciate their value.

Potential Tax Deductions

Another advantage is found in tax savings. Mortgage points, often called “discount points,” may be tax-deductible if you pay them at closing and itemize deductions on your tax return. If you buy $3,000 in points, you can deduct the full $3,000 on line 8a of IRS Schedule A (Form 1040).

Each of these actions will drastically lower your taxable income. These deductions greatly decrease the cost of homeownership, particularly during the early years of your mortgage.

For many buyers, this additional tax benefit will make buying points even more attractive. It’s definitely worth your time to work with a tax professional to understand just how these deductions may play out in your unique situation.

Drawbacks of Buying Mortgage Points

High Upfront Costs

The biggest disadvantage is that buying mortgage points requires spending more money upfront. Each point generally costs 1% of your loan amount. On a $300,000 mortgage, a point would cost $3,000.

In many cases, reducing your interest rate is advantageous. However, it does the equal of squandering that money by removing cash you need for other major expenses, like closing costs, moving fees, or home repairs.

It’s important to honestly evaluate your finances. If the upfront costs are going to strain your finances, think hard about this. Ultimately, the benefits you’ll get from buying points aren’t worth the extra financial strain.

If you’ve been saving for years to afford the down payment, the additional expense of buying points can put a major dent in your budget. You may end up cash-strapped for months following the purchase.

Risk of Selling or Refinancing Early

Mortgage points only make sense if you stay in the home long enough to recoup the initial cost through lower monthly payments. If you sell or refinance before reaching the breakeven point, you may never realize any actual savings.

Assuming you bought $5,000 in points and then sell the house and move in three years, those monthly savings may not take enough time to make up what you paid upfront. A change in life plans or financial needs may further make this a riskier option.

Limited Savings for Short-Term Loans

In fact, for shorter loan terms, such as 10- or 15-year mortgages, purchasing points might not provide significant savings. The shorter the loan, the shorter amount of time you will have to enjoy the savings from the lower interest rate.

On a 15-year loan, you may only get to the breakeven point after less than half the loan term. This timing makes it more difficult to find true savings opportunities.

Aligning your loan duration with your decision to buy points is critical to not paying for points you don’t need.

When to Buy Mortgage Points

Long-Term Loan Scenarios

Buying mortgage points usually makes sense—financially speaking—if you intend to live in your home for at least a few years. The lower the interest rate, the more your savings compound over time. This is particularly applicable with longer loan terms like 30-year loans.

Reduce your rate by a quarter of a percentage point with one point. This one little step can potentially save you thousands in interest! It isn’t only the total savings that matters, though—it’s your breakeven point. On average, you’d recoup your upfront cost of the points in around 30 months.

If you sell, refinance, or otherwise pay off the loan before this time period, the investment may not be worth it. Using a mortgage points calculator, such as the one available from Bankrate, can give you a better idea of how the math works in your unique situation.

Stable Financial Situation

Having a strong financial game plan is essential when considering purchasing points. Paying upfront costs, in this example $8,000 for two points, takes a level of consistent income, as well as a predictable and firm budget.

The investment pays off if you can comfortably afford your bills. Ensure you can cover your down payment and closing costs comfortably. Without a firm financial strategy, the extra upfront expense could place a serious burden on your finances.

If you are in a strong financial position, the potential savings on interest in the long-term can make buying points worth it.

High Interest Rate Environment

When rates are high, making the purchase of points more attractive. After all, lowering your interest rate by 0.25 percentage points doesn’t sound like much at first.

Over the life of the loan, it can result in thousands of dollars in savings. In this example, reducing your interest rate from 7% to 6.5% would save you almost $50,000 in interest. That’s over $30,000 on a conventional 30-year mortgage!

Understanding current market conditions allows you to determine if buying points makes sense financially for you.

When Not to Buy Mortgage Points

Short-Term Loan Plans

In fact, buying mortgage points may be a poor decision for borrowers looking at short-term loans. Even though paying points will lower your interest rate, the cost of the points takes a while to recoup through monthly savings.

For instance, if one point costs $3,000 on a $300,000 loan, you might never recoup the cost in years. If you have any intention to sell, refinance or pay the loan off early, don’t do it.

Or you won’t earn enough benefits overall to make up the initial purchase price. A breakeven analysis is critical here. Determine how long it will take for your savings to surpass the cost of those points.

That will allow you to determine whether the investment makes sense. In most short-term loan situations, the math usually works out on the side of not buying points.

Limited Upfront Funds

If you have limited cash available at closing, it’s a good idea to avoid buying points. Purchasing points means putting more money up front—this could stretch your budget too thin if you’re already having trouble making ends meet.

In these scenarios, lender credits are the better option. They help you to reduce your closing costs, but you will have to pay a slightly higher interest rate.

Finding the right balance between your monthly affordability considerations and your desire for upfront savings is important. For most buyers, the short-term needs of moving costs, emergency funds, or other immediate expenses will take precedence over the long-term benefit of points.

Uncertain Housing Plans

Imprecise housing plans make buying mortgage points a gamble. If you don’t plan to live in your home at least five years, don’t bother.

You may find yourself losing money on the cost of points. If you sell or refinance in a few years, you’ve paid a premium. You may not have enough years left on the loan to recoup those costs.

If you’re a buyer with an uncertain job location, need for lifestyle changes, or family needs, not buying points helps give you financial flexibility. Understanding your housing goals is key before you make the decision to buy down your rate.

Calculating the Breakeven Point

Understanding your breakeven point is crucial for home buyers to determine whether purchasing mortgage points makes financial sense, as it reveals when your initial outlay will be recouped in interest savings.

1. Determine the Cost of Points

The cost of mortgage points depends on many factors affecting mortgage rates.

Loan amount: Points are typically 1% of the loan. On a $200,000 loan, one point costs $2,000.
Some lenders may offer discounts or set different pricing structures.
Interest rate trends can influence the value of points.

2. Calculate Monthly Savings

To calculate savings, consider the interest rate for a loan with points and without points.

For example, cutting the interest on a $200,000 loan by 0.25% would save borrowers $30 a month.

While the savings compound over time, proper calculation is key to providing accurate planning for future expenses.

3. Divide Cost by Monthly Savings

To get the breakeven point, divide the point cost by the monthly savings.

For $2,000 in points saving $30 per month, it takes 67 months to break even.

Staying in the home any less than this risks going into the red.

4. Compare to Loan Duration

The longer the loan, the more valuable points become.

A 30-year loan typically makes point costs worthwhile, but it’s not true for shorter loans.

If you’re going to take advantage of these benefits, make sure your loan length matches your timeline.

Alternatives to Buying Mortgage Points

Negotiating a Lower Interest Rate

One of the easiest ways to reduce your interest rate without paying for points is to negotiate directly with your lender. What’s more, many borrowers don’t even know that interest rates are not necessarily set in stone. Improve your credit score right now! If you have a good credit history, lenders will be more willing to give you better rates.

For instance, credit scores over 760 usually qualify for better loan terms. If your credit score is not up to par, start improving it today! Focus on paying off your current debts and avoid incurring new ones ahead of applying for a mortgage. Skilled negotiation can save you big money over the long haul.

The difference a lower interest rate can make is enormous. For example, even a 0.25% decrease can save you tens of thousands of dollars on a 30-year loan. Finally, be ready to shop between lenders’ offers and use those offers as bargaining chips to get the best offer. Remember, lenders are competing for your business, so don’t be afraid to push for more favorable terms.

Increasing Down Payment

You can reduce your interest rate by making a larger down payment. The more money you put down up-front, the less risk the lender has. This usually results in a lower interest rate and more affordable monthly payment for you.

For instance, a 20% down payment could spare you from paying private mortgage insurance (PMI), which could save you hundreds of dollars a month. It’s definitely worth running the numbers. If you’re choosing between putting additional cash toward a larger down payment or buying points, consider the long-term savings.

Here are some key benefits that a larger down payment can offer you. This is particularly the case if you don’t plan to be in your home long-term. Saving for a larger down payment may take some time, but the savings in the long run will be worth it.

You can get there sooner by avoiding needless expenditures and putting extra money toward your goal. Keep in mind, a bigger down payment means you have more of your home owned outright right away, building equity faster.

Choosing a Shorter Loan Term

Choosing a shorter loan term, such as 15 years instead of 30 years, usually provides you with a lower interest rate. This is due to the fact that shorter loans lower the lender’s risk of non-payment through the duration of the loan.

Although your monthly payments will be larger, the potential long-term savings from decreased interest can be significant. For example, you might save tens of thousands of dollars on interest over the life of the loan. Shorter loan terms allow you to pay off your mortgage faster.

That benefit can come in handy, primarily if you intend to ride out your mortgage in your current home. What you need to make a priority is whether the increased monthly payments are within your means. If so, this option can be a very intelligent alternative to purchasing mortgage points.

Conclusion

By gaining a better understanding of mortgage points, you can take greater control over your loan costs and interest rate. By balancing the advantages and disadvantages, you’ll be able to determine whether or not purchasing points aligns with your financial objectives. If you pay points upfront, you will save more money in the long run. That only makes sense if you’re going to stay in the home long enough to recoup the cost. If you’ll need the cash flow to pay other expenses or if you plan to relocate in a few years, there may be better alternatives.

So take the time to do the math and think through your circumstances. Consult a trusted mortgage lender or financial advisor for guidance specific to your situation. Making the right choices today can mean huge reductions in your lifetime mortgage costs. Educate yourself, and take action to put yourself on the path to financial prosperity.

Frequently Asked Questions

What are mortgage points?

Mortgage points, often referred to as discount points, are fees paid upfront to secure a lower interest rate on your mortgage loan. Each mortgage point equals 1% of the total mortgage amount. By purchasing points, borrowers can reduce their monthly payment and achieve significant interest savings over the loan term.

How do mortgage points benefit borrowers?

Buying mortgage points enables you to secure a lower interest rate, which results in reduced monthly payments and less total interest paid over the life of the mortgage loan. This strategy is particularly beneficial if you plan to stay in the home for the long haul.

When should you consider buying mortgage points?

You should consider mortgage discount points if you plan to keep the mortgage for a long time and can afford the higher closing costs. This strategy is ideal for reducing your monthly payment and cutting total mortgage interest costs.

What are the drawbacks of mortgage points?

The upfront cost, including mortgage points, can be prohibitive and locks up cash. If you sell or refinance the home in a few years, recovering the cost of the mortgage loan points may not be possible.

How do you calculate the breakeven point for mortgage points?

To calculate breakeven time for your mortgage loan, divide the upfront cost of the mortgage discount points by your monthly payment savings. This gives you the payback period in months, which can lead to significant interest savings if you stay in the home long enough.

Are there alternatives to buying mortgage points?

You have more options than you might think when considering mortgage loans. By paying a larger down payment, selecting a shorter loan term, and negotiating with mortgage lenders, you can secure a lower rate without the need to buy discount points.

When should you avoid buying mortgage points?

Don’t buy mortgage discount points if you intend to sell or refinance in a few years, or if the upfront cost stretches your home buying budget. It isn’t worth it if you don’t plan to stay in the house long enough to recoup the mortgage point payments.