What are mortgage points and should you buy them?

One of the biggest factors impacting a mortgage payment is the loan interest rate. A lower interest rate can save you money each month and over the life of the loan.

That’s why lenders usually offer the option to purchase mortgage points. This practice allows borrowers to pay a fee upfront to secure a reduced interest rate.

Use our handy guide to learn how mortgage points are calculated and gauge whether buying mortgage points makes sense for your situation.

What are mortgage points?

A mortgage point – sometimes called a discount point (or a prepaid interest point ) – is a one-time fee you pay to lower the interest rate on your home purchase or refinance. One discount point costs 1% of your home loan amount.

For example, if you take out a mortgage for $300,000, one point will cost $3,000. When you purchase a point, you prepay the interest for a smaller monthly payment.

It’s possible to buy fractional points. So, using the example above, you could purchase 0.5 points for $1,500. You can also buy multiple points. Two points would cost $6,000. The more points you buy, the more you’ll decrease your interest rate.

How do mortgage points work?

Each discount point you buy reduces your interest rate by a set percentage point. The discount varies by lender, but you can generally expect a 0.25% interest rate reduction for each point purchased. Mortgage lenders cap the number of points you can buy.

Points are paid at closing or rolled into your loan. Your lender will calculate the cost of any points you purchased and add them to your other closing costs.

Generally, buying four mortgage points will lower your interest rate by 1 percent. That’s also the maximum number of points most lenders will let you purchase. If you don’t pay off your loan early, you’ll eventually save more in interest than you spent upfront.

Do mortgage points change your annual percentage rate?

A mortgage’s annual percentage rate (APR) includes the loan’s interest rate and any additional loan-related fees you pay over the course of a year.

So, if you purchase mortgage points to lower your interest rate, you’ll also lower your APR.

Mortgage points and adjustable-rate mortgages

Discount points work similarly for adjustable-rate mortgage (ARM) loans and fixed-rate loans. The only difference is that the interest on your ARM will adjust after 5 or 7 years, making it crucial to know how long it will take for buying points on a mortgage to be worth the investment.

The benefits of mortgage points

Borrowers buy mortgage points to lower their interest rate, but purchasing mortgage points also brings several other benefits.

Saving money over the life of the loan

Points can increase your closing costs by thousands of dollars. But this high upfront cost may be warranted if you stay in the home long enough to see savings from the reduced interest rate. Paying extra money upfront could mean tens of thousands of dollars in savings on your mortgage.

Lowering your monthly payment

Mortgage points can lower your monthly payment by decreasing your interest rate, which means you pay less in interest each month. Simply put, the less interest you pay, the smaller your monthly payment.

A Tax savings

You may be able to deduct the cost of the points from your taxes because mortgage interest is tax-deductible and discount points are considered prepaid mortgage interest. Discount points may be fully deductible if you pay them at closing and itemize your deductions on Schedule A from Tax Form 1040.

To understand the tax deductions you may be eligible for, check out the IRS rules on mortgage point benefits and speak with a qualified tax expert.

How much can you save by buying mortgage points?

The table below illustrates how much you can save by purchasing different mortgage point totals. This is based on a $350,000 loan with a base interest rate of 7%. It assumes an interest rate reduction of .25% for each full point purchased. It also assumes you’ll make the minimum required monthly payment each month for the full 30-year loan repayment term.

The table above is for educational purposes. Your lender should be able to provide you a more exact breakdown of how much you’ll save with points. But, the more points you purchase, the more you’ll save on interest over the loan repayment term.

Should you buy mortgage points?

Lower interest rates are great, but mortgage points may not be the best option for all home buyers. Some key items deserve consideration when deciding whether to buy points.

When to buy points on a mortgage

Buying mortgage points may be the way to go if:

• You want to stay in your home for a long time: The longer you stay in your home, the more sensible it is to invest in points and lower your mortgage rate. If you keep the same mortgage for the long haul, mortgage points can significantly reduce the overall cost of the loan.
• You know your breakeven point: Do the math to calculate when the upfront cost of the points will be eclipsed by the savings on your lower monthly mortgage payments. If your timing is right and you don’t plan on moving or refinancing your loan before reaching the breakeven point, buying points on a mortgage may be a financially savvy decision.

How to calculate your breakeven point

Let’s run through another quick example.

Typically speaking, if you have a $350,000 loan with a 7% interest rate and buy two points for $7,000, you’ll bring the loan’s interest rate down to 6.5% and save $117 a month on your mortgage payment.

If you divide the upfront cost of the points by your monthly savings, you’ll find that your breakeven point is about 60 months ($7,000 ? $117 = 59.83), which is about 5 years. If you plan to stay in your house longer than that, it’s shrewd to buy the points because you will pay $117 less per month for the remainder of your mortgage term.

When not to buy points on a mortgage

Mortgage points don’t make sense for every homeowner. You might not want to buy points if:

• You don’t plan to stay in your home for long: If you plan to sell in a few years, you won’t get the full benefit from discount points. It takes a few years for the money you save on interest to offset the cost of the points. If you know you’ll be moving soon, it’ll probably be hard to justify the expense of mortgage points.
• You plan to pay extra on your mortgage payments: Mortgage points benefit you more the longer you keep your home loan. If you pay off your loan way ahead of schedule, you might not save much or any money.
• You don’t have money to buy points: It’s not likely worth emptying your savings account to save on interest down the line. And buying points isn’t your only option to save on interest. You can also save on interest by paying extra toward your loan’s principal balance.
• Your down payment will suffer: Usually, it’s better to apply any extra cash to your down payment rather than points. A larger down payment may result in a lower interest rate, cheaper mortgage insurance (or no mortgage insurance) and lower monthly mortgage payments. Mortgage discount points will likewise lower your interest rate and reduce your monthly payment, but they won’t affect mortgage insurance and you’re likely to get an overall better bang for your buck by putting this money toward a down payment.
• You plan to refinance in the near future: Buying mortgage points may seem like a good idea when interest rates are high. But, if you plan on refinancing your mortgage to a significantly lower rate in the relatively near future soon, mortgage points may not be a wise investment.

The bottom line: Mortgage points may or may not save you money

While buying mortgage points makes sense for many borrowers, it won’t be financially beneficial for everyone. You’ll need to crunch the numbers to determine whether and how much you can save with discount points.

Sit down and evaluate your home buying budget, down payment, the conditions of the loan, your breakeven point and your future plans before heading to the closing table.

If you’re ready to buy a new home or want to refinance your home loan, you don’t have to wait. Get started on your mortgage application with Rocket Mortgage^® today.