Mortgage Points: What Are They, And Should You Buy Them?

When you decide to buy a house, you’ll have to pay interest on your home loan. Your lender will determine your interest rate based on your personal financial situation. If you have great credit, a strong income and minimal debts, your interest rate will likely be low. But if your finances aren’t ideal, you may end up with a higher rate.

Luckily, there are ways to lower your interest rate before you close on the loan. Mortgage points allow you to lock in a lower interest rate during the home buying process and pay less on your loan over time. Use this handy guide to understand how they’re calculated, and to gauge whether buying mortgage points makes sense for your situation.

A mortgage point – sometimes called a discount point – is a fee you pay to lower your 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 $100,000, one point will cost you $1,000. Purchasing a point means you’re prepaying the interest to have a smaller monthly payment.

Points are paid at closing, so your lender will calculate the cost of any points you agree to purchase and add those charges to your other closing costs.

For each discount point you buy, your interest rate will be reduced by a set percentage point. The per-point discount you’ll receive varies by lender, but you can generally expect to get a .25% interest rate reduction for each point you buy. Most mortgage lenders cap the number of points you can buy. Generally, points can be purchased in increments down to eighths of a percent, or 0.125%.

For example, let’s say you take out a $200,000 30-year fixed-rate mortgage at 5.125%. Your lender offers you an interest rate of 4.75% if you purchase 1.75 mortgage points. On a $200,000 loan, each point costs $2,000, which means that 1.75 points will cost $3,500.

If you choose not to buy mortgage points, your interest rate will remain at 5.125%. Over 30 years, without paying down the loan early, the cost of the loan, with interest, is $391,809.

However, if you opt for the 1.75-point discount, you end up paying $375,586 over the life of the loan. This means that paying points saved you $16,223 over the course of your 30-year mortgage.

Discount points for an adjustable-rate mortgage loan work the same as with a fixed-rate one. The only difference is that your loan will adjust after 5 or 7 years, so it’s crucial to know how long it will take to make buying points on a mortgage worth the investment.

How Mortgage Points Differ From Mortgage Origination Points

You might have also heard the term “mortgage origination points.” This refers to the origination fees paid to your mortgage lender for the processing and assessment of your loan. Sometimes you can negotiate these charges with your loan officer, depending on your credit score and down payment. However, these points will not lower your interest rate.

People buy points to lower their interest rate and save on the overall cost of the loan.

Buying Points May Save You Serious Money

Points can increase your closing costs by thousands of dollars, but the large upfront cost might be worth it if you stay in the home long enough to see savings from the reduced interest rate. Paying an extra $2,000 upfront could mean tens of thousands of dollars in savings over the course of your mortgage. However, if you plan to sell your home or refinance before you break even, paying for points might not be worth it.

You May Lock In A Lower Monthly Payment

Points can also get you a lower monthly payment. Since mortgage points help you lower your interest rate, you’ll have to pay less in interest each month. The less interest you pay, the smaller your monthly payment will be.

You May Save On Taxes

Since mortgage interest is tax-deductible and points are considered prepaid mortgage interest, you may be able to deduct the cost of the points on your taxes. To understand the deductions you may be eligible for, check out the IRS rules on mortgage point benefits and speak with a qualified tax expert

Lower interest rates are always great, but mortgage points might not be the right solution for every home buyer. Here are some things to consider when you’re determining whether to buy points.

When To Buy Mortgage Points

Buying mortgage points might make sense if any of the following situations apply to you:

• You want to stay in your home for a long time. The longer you stay in your home, the more it makes sense to invest in points and a lower mortgage rate. If you’re sure you’ll have the same mortgage for the long haul, mortgage points can lessen the overall cost of the loan. The longer you stick with the same loan, the more money you’ll save with discount points.

• You’ve determined when the breakeven point is. Do some math to figure out when the upfront cost of the points will be eclipsed by the lower mortgage payments. If the timing is right and you know you won’t move or refinance before you hit the breakeven point, you should consider buying points.

How To Calculate Your Breakeven Point

Let’s run through a quick example using the numbers referenced earlier.

If you have a $200,000 loan amount, going from a 5.125% interest rate to a 4.75% interest rate saves you $46 per month. As mentioned earlier, the cost of 1.75 points on a mortgage with a $200,000 loan amount is $3,500. If you divide the upfront cost of the points by your monthly savings, you’ll find that your breakeven point is about 76 months ($3,500/$46 equals 76.01), which is equal to roughly 6 years and 3 months. So, if you plan to stay in your house for longer than that amount of time and pay off your loan according to the original schedule, it makes sense to buy the points because you’ll save money in the long run.

When Not To Buy Mortgage Points

Mortgage points don’t make sense for every homeowner. Here are some reasons not to buy them:

• You don’t plan to stay in your home for long. If you’re a wandering soul who loves to move from place to place every few years, you won’t get much benefit from discount Points are a long-term strategy to pay less interest over time. It takes a few years for the money you save on interest to surpass the amount you spend to buy the points. If you know you’ll want to move at any point in the near future, points may not be worth the cost.

• You plan to pay extra on your mortgage payments. Mortgage points will only benefit you if you pay on your home loan for a long time. If you have the means to pay off your loan quickly, you might not end up saving much money.

• You don’t have the money to buy points. It’s not worth emptying your savings account to save on interest down the line. Instead, you could save on interest in the long run by putting extra money toward your principal when you have the cash.

• Your down payment would suffer. It’s usually better to apply extra cash to your down payment than to points. A larger down payment could mean a lower interest rate, cheaper mortgage insurance (or none at all) or lower payments. Mortgage discount points don’t come with all of these benefits.

• You plan on refinancing in the near future. When interest rates are high, buying mortgage points may seem like a good idea. But if you plan on refinancing your mortgage in the near future, you’ll have to pay origination points and discount points again for the new loan. That means you’ll end up paying for the same things twice.

Though mortgage points and prepaid interest are right for some borrowers, they don’t make financial sense for everyone. To determine whether you can save with discount points, you have to crunch the numbers.

Sit down and assess your budget, down payment, loan terms and future plans before you close. Determine your breakeven point and your likelihood of staying in the home to understand if discount points will save you money in the long run when refinancing or buying a home.

If you’re ready to buy a new home or need to refinance your existing home loan, don’t wait. Apply online with Rocket Mortgage®.