Mortgage Points: What They Are and How They Work
A mortgage point is an upfront fee you pay to reduce your mortgage interest rate. Mortgage points can help you save on interest charges each month and over the entire loan term. Here’s what you need to know when deciding whether to add points to your total closing costs.
- Mortgage points allow you to permanently reduce the interest rate on your home loan in exchange for an upfront fee.
- Points typically cost 1% of the total loan amount, and each point usually lowers your interest rate by up to 0.25 percentage points.
- Buying points will cost you more upfront, but can help you save on interest charges each month and over the life of the loan.
What are points on a mortgage?
Mortgage points — also known as discount points — are upfront fees you pay to your lender in exchange for a lower interest rate on your mortgage loan. This is also known as “buying down your interest rate” because it effectively lowers the total interest you’ll pay over your repayment term.
How much do mortgage points cost?
Mortgage points are calculated as a percentage of your loan amount: One point typically equals 1% of the amount you borrow. For example, one point on a $350,000 loan would cost you $3,500 ($350,000 x 0.01 = $3,500).
But not all points are created equal, so you should rate shop with at least three lenders and ask your chosen lender for clarification on the rate discount once you’re ready to move forward.
One important note: Any points you find listed on Page 2, Section A of your loan estimate or closing disclosure must earn you a lower interest rate by law, according to the Consumer Financial Protection Bureau (CFPB). If they don’t, pick a different lender — you may be getting scammed.
How do mortgage points work?
Mortgage points shave off fractions of a percentage point from your interest rate, which can save you thousands of dollars on a 30-year mortgage. You’ll typically reduce your interest rate by up to 0.25 percentage points for every discount point you buy.
For example, you could reduce your rate from 6.75% to 6.50% by buying one point. However, you don’t have to stick to buying one point at a time. You could choose to only buy a fraction of a point or buy multiple discount points.
You’ll pay for these points as part of your total closing costs when you close on the loan.
Mortgage points example
On the surface, the rate and payment savings don’t look very impressive. But when you consider lifetime savings, discount points become more appealing. The example below compares options on a 30-year fixed-rate mortgage with a $350,000 loan amount, assuming the borrower was quoted a 6.50% rate with no points.
| Interest rate | Discount points | Discount point cost | Monthly principal and interest payment | Lifetime interest paid | Monthly savings | Lifetime interest savings |
|---|---|---|---|---|---|---|
| 6.50% | 0 | $0 | $2,212.24 | $446,404.28 | N/A | N/A |
| 6.25% | 1 | $3,500 | $2,155.01 | $425,803.81 | $57.23 | $20,600.47 |
| 6.0% | 2 | $7,000 | $2,098.43 | $405,431.62 | $113.81 | $40,972.65 |
When you buy discount points on a loan, you’re permanently reducing the interest rate. However, there are some cases — like when you’re getting a new construction loan — that the lender may temporarily buy down the interest rate.
One common example of this is a 3-2-1 buydown. In this scenario, the buyer pays a rate that is 3% lower during the first year of the loan term, 2% lower during the second year and 1% lower during the third year. After that, the buyer pays the full interest rate, unless they refinance the loan.
Pros and cons of buying mortgage points
- A lower mortgage payment: The extra cash you save each month can be added to your college tuition budget, retirement account or an emergency fund.
- Less interest over time: As the example above shows, paying less interest over the loan term can add up to a new car, a down payment on a vacation home or that dream family trip to Europe.
- Potential tax deduction: Mortgage discount points may be tax-deductible.
- Higher closing costs: You’ll pay more in total closing cost with mortgage interest points attached.
- Longer break-even point: It’ll take you longer to break even on the upfront costs of buying a home.
- Less financial flexibility: Putting money into buying discount points could hamper your ability to reach other financial goals, such as building an emergency fund or paying off debt.
Expert take: Should you buy mortgage points?
If you’re buying what you hope to be your forever home, buying points can be a wise move. One of the keys to buying points is being in the home long enough for the overall savings to outweigh the upfront costs. If you’re going to be in that house for 30 years, that shouldn’t be a problem. If you’re only going to be there for two or three years, it might be.
When should you buy mortgage points?
Mortgage points aren’t cheap, especially if you’re borrowing a lot of money for your home purchase. In most cases, it makes sense to pay for points if:
- The home seller is paying your closing costs. If you’ve haggled for the seller to pay some of your costs, set aside a chunk to buy a lower rate on the seller’s dime.
- You’ll recoup the cost before you sell your home. Divide the cost of the points you’re buying by your monthly savings to learn how many months it will take to hit your break-even point. It doesn’t make sense to pay for points if you won’t be in the home long enough to enjoy the savings.
When to avoid buying mortgage points
Don’t spend the money on discount points if:
- You’re strapped for cash. Homeownership comes with the downside of leaky roof repairs, toilet clogs and upkeep, all of which cost money. If your rainy-day fund can only handle a sprinkle, put the cash you’d spend on discount points into your emergency fund instead.
- You plan to sell your home soon. If you’re a year or two away from selling your home, or won’t be there long enough to break even on your point costs, skip the points and keep the cash for moving expenses or a larger down payment on your next home.
When getting a mortgage, your break-even point tells you how long you’d have to stay in your home to reap the savings from upfront costs like mortgage discount points.
To do this, simply divide the total cost of your mortgage points by the savings you see in your monthly mortgage payment.
Break-even point example
Using the numbers from the example above, if you bought two mortgage discount points, you would pay $7,000 extra in closing costs and save $113.81 on your monthly mortgage payment.
The math looks like this:
7,000 / 113.81 = 61.5
According to the math, you’d need to stay in your home for at least 61.5 months (a little more than five years) before you break even and start to see savings after buying mortgage points.
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Frequently asked questions
As many as you can afford. Just remember: The more you spend, the longer it will take to hit your break-even point.
Yes. The IRS lets you write off points on a home purchase over time. Check with your tax expert for advice on what’s best for you.
Yes, if it helps you afford the monthly mortgage payment, you have the cash to pay for the points and you plan to stay in the home long enough to break even on your costs.
Your annual percentage rate (APR) reflects your loan’s interest rate and financing costs. Buying points lowers your interest rate, but it also increases the upfront costs of borrowing — so it could potentially increase the APR. But the interest savings over the loan term offsets what you spend at closing, as long as you stay in the home past your break-even point.
An origination point doesn’t have anything to do with getting you a lower rate. Rather, it’s a closing cost lenders charge to approve your loan, pay your loan officer, prepare your closing documents and disburse your money. In a nutshell, it’s the lender’s cost of doing the business of originating your loan.
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