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Mortgage Points: How They May Get You a Lower Interest Rate

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If you’re looking for the lowest home loan rate possible, paying mortgage points may be worth considering. A lower rate means a lower mortgage payment and extra long-term savings. However, paying points on a mortgage doesn’t always make sense, and understanding how points work will help you decide if they’re worth the cost.

What are mortgage points?

Mortgage points are upfront fees calculated as a percentage of your loan amount. Also called “discount points,” mortgage points are typically paid in exchange for a lower interest rate. However, some lenders use just the word “points” to refer to a percentage of fees related to your loan amount, even if they don’t lead to a lower interest rate.

How much is a mortgage point?

One point equals 1% of your loan amount. For example, one point on a $300,000 loan would cost you $3,000. Any points you find listed on Page 2, Section A of your loan estimate or closing disclosure must “buy” you a lower interest rate by law, according to the Consumer Financial Protection Bureau (CFPB).

Shopping for the lowest rate for the mortgage points you pay is especially important. Lenders set their own interest rate pricing structures, so make sure you collect at least three to five rate quotes to compare.

How do mortgage points work?

You don’t need to know how to calculate mortgage points to calculate your savings, because lenders are required to generate loan estimates that reflect the exact cost of points charged. However, it’s useful to understand how a mortgage points break-even calculator works to help you decide if paying points on your mortgage is worth it.

We’ve provided an example below using our mortgage calculator for a $300,000 loan, assuming each point reduces your interest rate by 0.25%.

0 points 1 point 2 points
Points cost $0 $2,500 $5,000
Interest rate 3.75% 3.50% 3.25%
Monthly principal and interest payment $1,389.35 $1,347.13 $1,305.62
Total interest paid $200,164.84 $184,968.26 $170,022.82
Monthly payment savings vs. 0 points N/A $42.22 $83.73
Lifetime interest savings vs. 0 points N/A $15,196.58 $30,142.02
Months to break even on discount point costs N/A 59.2 months 59.7 months

The bottom line from the above example: 

  • Paying two points versus one point saves you nearly twice as much interest.
  • The break-even point for each buydown option is nearly the same.
  • If you have the cash to pay the points, you’ll recoup the costs in about five years for each option.
  • If you plan to stay in your home at least five years, paying points will save you as much as $83.73 per month and up to $30,142.02 in lifetime interest.

Should you buy mortgage points?

You should buy mortgage points if you have the resources to pay for them and plan to stay in your home long enough to recoup them. There are a few other situations where it may make sense to pay points for a mortgage:

The seller has agreed to pay your closing costs. Some loan programs allow a seller to pay a percentage of your sales price toward your closing costs, which is commonly called a “seller concession.” If you’re able to negotiate this into your purchase agreement, it may be worth it to use the seller’s money to buy a lower interest rate. The table below gives you a snapshot of the maximum percentage of your purchase price the seller is allowed to pay on your behalf:

Loan program Maximum percentage of sales price the seller can pay
Conventional
  • 3% (up to 10% down payment
  • 6% (10% to 25% down payment
  • 9% (25% or more down payment)
FHA
  • 6%
VA
  • 4%

The homebuilder is offering incentives toward your closing costs. If you’re having your home built, sometimes the builder will offer a closing costs incentive if you use their preferred lender. Consider using the incentive to get a better interest rate.

Pros and cons of buying mortgage points

Pros

  • You’ll typically get a lower interest rate.
  • You’ll have a lower monthly payment.
  • You’ll save money on interest charges over the life of the loan.
  • You may be able to deduct the cost of mortgage points at tax time.

Cons

  • You’ll need to budget for the extra cost of points.
  • You’ll have higher total closing costs.
  • You’ll need to stay in your home long enough to recoup the costs.
  • You’ll lose money if you sell your home before breaking even.

FAQs about mortgage points

How do mortgage points affect my APR?

You can expect a higher annual percentage rate (APR) on your loan. Because APR reflects the total costs paid over the life of the loan, the more you pay in closing costs, the higher your APR will be.

What is the difference between origination points and mortgage discount points?

Origination points are upfront charges from your lender for funding your mortgage, while mortgage points are paid in exchange for a lower interest rate. 

Can you negotiate points on a mortgage? 

You should always shop several lenders to make sure you get the best bang for your “mortgage points” buck. Some lenders may offer significantly better rates for your scenario.

Are mortgage points tax-deductible?

You may be eligible to deduct mortgage points, along with your interest payments. You’ll typically deduct the amount over the life of the loan, although there is an exception that allows you to deduct the entire amount in the year you pay them.

Who pays mortgage points on a home purchase?

You may be able to get the seller to pay points on your behalf as part of a closing cost concession. Ask your loan officer about this option if your seller has agreed to pay closing costs based on a percentage of the home’s sales price.

 

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