Are you ready to get a mortgage but worried about your mortgage interest rate? Mortgage points could help. The interest savings that come from buying points isn’t free, though. You’ll have to pay for each point you buy, meaning you must determine whether the upfront money you spend on these points is worth the interest you’ll save by lowering your rate.
Let’s take a deep dive into how mortgage points work, the pros and cons of buying points, and how much they’ll cost you.
What Are Points On A Mortgage?
Mortgage points, often called discount points, are a way for home buyers to pay to lower the interest rate on their home loan. Each mortgage point costs 1% of your mortgage amount and will lower your interest rate by approximately 0.25%.
For example, if your lender quotes you an interest rate of 6.5% on your $200,000 mortgage, you’ll likely have the option to buy points to lower that rate. If you buy two points for $4,000, you’ll shave .50% off that rate, dropping it to 6%.
Mortgage points are considered part of closing costs you’ll pay your lender and other third-party providers to originate your mortgage loan. These costs are usually 3% to 6% of your mortgage loan amount. You can pay them upfront when you close on your mortgage or add them to your total mortgage amount, meaning you’d pay them back over time when you make your monthly mortgage payments.
Mortgage Points Vs. Origination Points
You might hear the term “origination points” or “origination fees” when applying for a mortgage. These aren’t the same as mortgage or discount points.
Origination points represent the fees you pay your lender to originate your mortgage loan. These will vary by lender, but one origination point typically equals 1% of your mortgage loan amount.
If you’re borrowing $300,000 and your lender charges 1.5 origination points, you’ll pay $4,500 to your lender for originating your loan.
Unlike mortgage points, origination points won’t lower your mortgage’s interest rate.
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How Do Mortgage Points Work?
There’s no set limit on the number of mortgage points you can buy. Typically, though, most lenders will only let you buy up to four mortgage points.
When you’re shopping for a mortgage and determining whether buying points makes sense, you must first calculate how long it would take you to recoup the upfront costs of purchasing these discount points. This is known as the breakeven period.
To determine a loan’s breakeven period, a borrower will need to divide the costs of their points by how much they’ll save on their payment each month. This will give you the number of months it’ll take for your monthly savings to equal the upfront costs of your discount points.
How Much Do Mortgage Points Cost?
Mortgage points aren’t free. One point costs 1% of your mortgage loan amount. If you’re borrowing $325,000, then, you’ll spend $3,250 for one point or $6,500 for two.
Because each point reduces your interest rate by 0.25%, you’ll need to buy four points to reduce your rate by a full percent.
Mortgage Loan Points Example
Here’s an example of how to determine your breakeven point when buying mortgage points. To do your own calculations, use our mortgage amortization calculators.
Suppose you borrow $300,000 with a 30-year fixed-rate mortgage. Without points, your interest rate will be 6.5%. If you buy one point, you’ll pay $3,000 upfront and lower your interest rate to 6.25%.
By purchasing one point, you’ll reach your breakeven point in about 61 months, or 5 years and 1 month. Your monthly mortgage payment – not including taxes or homeowners insurance – without the point you purchased would be $1,896. With your point, that figure falls to $1,847, resulting in a monthly savings of $49.
If you stay in your home for the full 30 years of your mortgage, you’d save $17,640 by lowering your interest rate from 6.5% to 6.25%.
Loan: $300K, 30-year fixed-rate mortgage, 6.25% interest rate (down from 6.5% without points)
Mortgage Loan Points Example
Mortgage Points Cost | Monthly Savings | Months To Breakeven Point | Total Savings |
|---|---|---|---|
1 = $3,000 | $49 | 61 months | $17,640 |
The Pros And Cons Of Mortgage Discount Points
As with most financial decisions, buying mortgage points comes with both positives and negatives.
Pros Of Mortgage Points
Here are a few benefits of buying mortgage points:
- By buying points, you’ll lower your interest rate and the amount of interest you pay over the life of your loan. This could save you tens of thousands of dollars, depending on your final interest rate and the amount you’re borrowing.
- By lowering your interest rate, you’ll also lower your monthly mortgage payment. This could help you purchase a home that might otherwise be out of your price range.
- Mortgage points are tax-deductible. By buying points, you can lower the income taxes you pay if you itemize taxes.
Cons Of Mortgage Points
A couple of drawbacks associated with buying mortgage points include:
- Points are expensive, typically costing 1% of your mortgage amount. If you buy points, it could take several years for the interest savings they generate to equal the amount you pay for them.
- Buying points increases the amount you pay in closing costs. These are the fees you pay to your lender and other third-party providers to originate your loan. The fees compensate real estate attorneys, title insurance companies, inspectors and others for their services.
- If you plan on moving or refinancing anytime soon, you might not reach the breakeven point in which the interest savings from mortgage points outweigh the cost of these points.
FAQ
Below are answers to a few frequently asked questions about mortgage points.
Should I buy mortgage points or make a larger down payment?
If you’re taking out a conventional loan and don’t have the money for a down payment that’s 20% of your home’s purchase price, you’ll have to pay private mortgage insurance (PMI) as part of your monthly mortgage payment. PMI is typically 0.1% to 2% of your remaining principal mortgage loan balance at any given time.
This could factor into your decision to buy points. If you have enough money to come up with a 20% down payment, it will probably make more sense to use your dollars on that than on buying points.
A larger down payment will often give you a lower interest rate, too. Talk with your lender to determine whether you’ll get a lower interest rate by making a bigger down payment or buying points.
Is buying points on a mortgage worth it?
Buying mortgage points can be worth it, especially if you plan on living in your home for a fairly lengthy period of time. The longer you stay in your home, the more money you’ll save by buying points. If you plan on moving after just 5 years or so, it’s probably a better financial choice to skip the points.
If you plan on living there much more than 5 years, buying points will typically pay off.
Are mortgage points tax-deductible?
Mortgage points are considered prepaid mortgage interest. On tax returns for 2023, you’re allowed to deduct the interest you pay on up to $750,000 worth of mortgage debt unless you’re married and filing separately. In that case, you can deduct the interest you pay on up to $375,000 of mortgage debt.
To claim this tax benefit, you’ll need to fill out IRS Form 1040, Schedule A and itemize your deductions.
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The Bottom Line
While mortgage points can help reduce the amount of interest you pay on your loan, buying them isn’t the right choice for everyone. You’ll need to determine how long you plan on staying in your home and how long it’ll take your interest savings to surpass the cost of buying points.
