Mortgage Points: What Are They, And Should You Buy Them?
Hanna Kielar8-minute read
August 06, 2021
Mortgage points are a way to lock in a lower interest rate and pay less on your loan over time. Use our guide to understand how points are calculated and gauge whether buying mortgage points makes sense for your situation.Whether you’re looking to make a purchase or refinance your home, understanding mortgage points can give you a better idea of the relationship between closing costs and your interest rate. Table of Contents:
What Are Mortgage Points?
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 loan amount. For example, if you take out a mortgage for $100,000, one point will cost you $1,000. For a $200,000 loan, a point costs $2,000.
How Do Mortgage Points Work?
For each discount point you buy, your interest rate will be reduced by a set percentage point. When your interest rate is reduced, this can result in a lower monthly mortgage payment. The per-point discount you’ll receive varies by lender, but you can generally expect to get a 0.25% interest rate reduction for each point you buy.
Most lenders cap the number of points you can buy, and most allow you to purchase a fraction of a point. Generally, points can be purchased in increments down to eighths, or 0.125%.
How To Calculate Mortgage Points
When calculating potential savings, determine how much your mortgage would cost with interest. Once you have that number, you can play around with the calculations for different interest rates depending on how many points you’re interested in buying. Subtract the total cost of the mortgage with points from the total cost of the mortgage without points to determine how much money you’d be saving throughout the loan.
Let’s say you take out a $200,000, 30-year fixed-rate mortgage at 4.125%. Your lender offers you an interest rate of 3.75% if you purchase 1.75 mortgage points. On a $200,000 loan, each point is equal to $2,000, which means that 1.75 points is equal to $3,500.
If you choose not to buy mortgage points, your interest rate will remain at 4.125%. Over 30 years, without paying down the loan early, the cost of the loan with interest is $348,947.70.
However, if you opt for the 1.75-point discount, you end up paying $333,443.38 over the life of the loan. This means that paying for points upfront saved you $15,504.32 over the course of your 30-year mortgage.
The Benefits Of Mortgage Points
People buy points to lower their interest rate and save on the overall cost of the loan. Though you’ll be paying extra upfront, the long-term savings may be worth it. Here are some benefits of purchasing discount points:
- Buying points can save you money over the course of your loan. 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.
- Points can also be a way to get a lower monthly payment. If your monthly mortgage payment puts too much of a strain on your budget, mortgage points could be a way to save. A lower interest rate equals lower monthly payments.
- You also may save on taxes if you decide to purchase mortgage points. 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.
Are Mortgage Points Worth It?
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 mortgage points. 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 mortgage points.
How do you calculate that 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 4.125% interest rate to a 3.75% interest rate saves you $43.07 per month. As mentioned earlier, the cost of 1.75 points on 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 81.3 months.
$3,500 / $43.07 = 81.3
If you plan to stay in your house for longer than 6 years and 10 months 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.
- You have the cash to buy the points at closing. Putting down less than 20% on a conventional loan might mean you’ll have to pay private mortgage insurance (PMI) each year – which typically costs about 1% of the total loan amount. If you’re able to make a larger down payment, not pay or pay less in PMI fees and still have the funds to buy the points, it can lead to great savings. Make sure to calculate how much you’ll be paying for PMI to make sure your discount points aren’t costing you more.
When Not To Buy Mortgage Points
Mortgage points don’t make sense for everyone. Here are some reasons not to buy them:
- You don’t plan to stay in your home for long. If it’s not your forever home and you’re a wandering soul who loves to move from place to place every few years, you won’t get much benefit out of mortgage points. 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 override the amount you spend to buy the points. If you know you’ll want to move at any point in the near future and sell your home, mortgage points aren’t worth the cost. Always look at your breakeven point to determine whether or not buying mortgage points makes sense for you.
- You plan to pay extra on your mortgage payments. Mortgage points will only benefit you if you pay on your 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 monthly payments. Mortgage discount points don’t come with all of these benefits.
Mortgage Point FAQs
Buying discount points seems like a great idea – lower interest rate, lower monthly payment and greater savings over time – but they aren’t always the smartest option for everyone. The following section highlights answers to some additional questions you may ask yourself when deciding whether or not to buy mortgage points.
How Much Do Points Cost?
One point costs 1% of your total mortgage amount. So, 1 point on a $200,000 mortgage would be $2,000. Mortgage points are to be paid in addition to the closing costs – which usually range anywhere from 3% – 6% of the price of the home. For example, if you were to pay 3% in closing costs on a $200,000 loan and purchased one discount point, you would need to pay $8,000 at the time of closing.
How Many Points Can You Buy On A Mortgage?
How many points you can purchase varies from lender to lender, but it typically ranges anywhere from one to three points. As mentioned, points can also be purchased in increments down to eighths. You can usually expect each full point purchased to lower your interest rate by 0.25%, but per-point costs can vary based on your lender’s offerings.
Are Mortgage Points Tax Deductible?
Since mortgage points are prepaid interest, you may be able to deduct the points you paid on your mortgage in addition to your home mortgage interest. To take advantage of this, you’ll need to itemize your deductions on your tax return. For those filing jointly, you can deduct interest on the first $750,000 of mortgage debt or $375,000 for single filers or married and filing separately. If your mortgage points exceed this limit when combined with your mortgage interest, you may not be able to deduct all of the points.
Can You Buy Discount Points After Closing?
No, you can’t buy discount points after closing. Once the paperwork is signed and closing costs have been paid, you’re not able to go back and buy points or add any additional points. Make sure you’re set on your decision to purchase or not purchase points prior to closing so you’re not left wishing you would have gone with a different option.
Can You Negotiate Points On A Mortgage?
Yes, it’s always a good idea to shop around from lender to lender to see who’s giving you the best rate. Some lenders may already be adding points to your mortgage to make the interest rate look lower. Always be sure to ask lenders for a zero-point loan offer so you can compare rates fairly from lender to lender. Negotiating the per-point discount can help reduce your interest rate, thus leading to higher overall savings over the course of your loan.
Though mortgage points may be 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 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 buying or refinancing a home.
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