In early 2021, mortgage rates hit an all-time low and have remained historically low ever since – presenting a money-saving opportunity for those fortunate enough to be in a position to buy or refinance a home.
But there’s another way to get a lower interest rate—for a price.
Purchasing mortgage points, also known as “buying down the rate,” is a strategy that involves paying additional money upfront at closing in order to shave down the interest rate of your loan.
Generally, buying mortgage points is only worth your while if you plan to stay in your home for several years, usually at least six. Beyond that, it’s a matter of balancing priorities. Would you rather spend that money upfront to buy down your rate, or does it make more sense to put down a larger down payment—or even sock that money away into your 401(k) account?
Here are the things to consider when evaluating mortgage points.
What Are Mortgage Points?
Lenders offer mortgage points, also known as discount points, when you apply for a mortgage. Mortgage points are paid to the lender at your closing in exchange for a lower interest rate. Lenders also refer to mortgage points as “buying down the rate.”
Choosing to take points on a mortgage is completely optional, but it is one way to lower your overall interest rate and your monthly payment. Most lenders let you purchase between one and three points (sometimes less, sometimes more) which you pay upfront as part of your closing costs. One point equals 1% of your mortgage, or $1,000 for every $100,000. The monthly savings that result will depend on the interest rate, how much you borrow, and the term of the loan.
The length of time you plan to be in the home is crucial to your calculations. It typically takes a borrower between 4-6 years to recoup the cost from paying discount points at closing, says David Reischer, a real estate attorney at LegalAdvice.com, an online legal consultation tool.
Keep in mind mortgage points are usually only used for fixed-rate loans. They are available for adjustable-rate mortgages (ARMs), but they only lower your rate for your introductory period until the rate adjusts, which does not make the investment worth it.
How Mortgage Points Affect Your Loan
The table below will show you just how much points cost, how much you can save, the discount you could see on your rate, and how long it takes to break even using the example of a 30-year, 3.53% rate, and $250,000 loan.
Will You Break Even?
30-Year Fixed, $250,000 Loan
|Points||APR (Before discount)||APR (with 0.25% discount per point)||Points Cost (1 point=1% of loan)||Monthly Payment (principal plus interest)||Savings Per Month||Break Even – Number of Months|
As you can see, investing $5,000 upfront to buy down two points will reduce your rate from 3.53% to 3.03%, saving you $68 on monthly mortgage payments. Once your $5,000 is paid back after about six years, you will start to see savings. In this example, a savings of $68 per month can turn into $816 saved per year, and $8,160 saved on your loan over the following 10 years. Between the break-even point and the end of the 30-year term, the savings would ultimately add up to about $19,000.
The catch: you’ll need the discipline to actually put away the $68 you saved each month.
Run the numbers to see how much mortgage points could save you—and whether that money would be better spent (or invested) elsewhere.
Are Discount Points Worth it?
“Generally, buying mortgage points is the most beneficial when you can comfortably afford them and plan to stay in your home for a long period of time,” says Baruch Silvermann, CEO and founder of The Smart Investor, an online investment education site.
Finally, note that buying a home means setting yourself up for the bevy of expenses that come with owning a property, from taxes to repairs. You’ll need to have enough cash to make a down payment, cover closing costs (which can equal 2 to 5% of your purchase price) and have enough savings leftover to get you through any emergencies or loss of income. If purchasing points leaves you without sufficient savings, it may be a risky proposition.
Before you decide, compare your options with other investment opportunities. We find investing in your retirement and 401(k) can see the best rewards. The compound interest on $5,000 does not come with any strings attached compared to buying points. Meaning, it’s not dependent on whether or not you move, refinance, or have the discipline to save the $68 difference each month. It is a set-it-and-forget-it approach.
To decide for yourself if mortgage points are worth it, ask yourself if you can afford the cost of and all other closing costs. Determine if you’re planning to be in your home long enough to recoup the cost of mortgage points. Only then will you feel confident to decide if discount points are worth it.
What Are Mortgage Origination Points?
Mortgage origination points are fees you pay to a lender for the processing of your home loan. These fees are how loan originators get paid.
Each point is 1% of the total loan amount. One point on a $200,000 loan would be a $2,000 charge. Because a single point has a higher total dollar value for a larger loan, you are likely to have more success negotiating smaller origination fees (as a percentage of the loan balance) if you have a larger mortgage balance.
Can You Negotiate Points on a Mortgage?
Discount points are an entirely optional fee for your mortgage and you should be aware of any points you are paying. Some lenders will advertise exceptionally low mortgage interest rates, only to have a substantial amount of discount fees built into that price.
It’s a good practice to review your Loan Estimate to confirm what fees you are paying. Discount points will be listed under the origination charges on page 2 in box A.
Are Mortgage Points Tax Deductible?
Mortgage points may be tax-deductible as mortgage interest on your primary residence if you meet the IRS requirements. First off, you’ll need to itemize your taxes, which is less common since the standard deduction was increased for 2021 to $12,550 for individuals, $18,800 for heads of households, and $25,100 for joint filers. Unless all of your deductions are greater than the standard deduction, you won’t have any tax savings from paying discount points.
As with anything related to your taxes, it’s a good idea to consult with a tax advisor to ensure that you are taking advantage of every deduction available to you and properly documenting everything.
This article was updated on Sept. 4, 2020, to remove comments made by a source whose credentials do not meet NextAdvisor editorial standards.