Mortgage Points: What Are They And How Do They Work?

Picking out a mortgage lender is one of the most important pieces of buying a new home. You want to find a mortgage offering the lowest interest rate possible. Unfortunately, if your credit is less than excellent, you may end up with a higher rate than you’d like.

Enter mortgage points. Many lenders give homebuyers the option to buy mortgage points, allowing them to lower their interest rate. In this article, we’ll dive into mortgage points so you understand how they work and the savings you might expect when purchasing them.

What are mortgage points?

Mortgage points are a one-time fee that a borrower can pay to help lower the interest rate on their mortgage. One point will typically cost 1% of the loan value. For example, if you’re applying for a $400,000 loan and want to purchase one point, it would cost $4,000. That one point will then reduce your mortgage rate by 0.25%. By lowering your interest rate, you’ll be reducing your monthly mortgage payment.

How do mortgage points work?

Each mortgage point you purchase helps reduce the interest rate on your loan. The lender determines the discount, but typically, each point will reduce the interest rate by 0.25%. Most lenders will also allow you to buy partial points. That means on a $400,000 loan, you could purchase 1.5 points for $6,000.

Before you purchase mortgage points, discuss the details with your loan officer or read the fine print because the particulars can fluctuate from one lender to the next. If you decide to purchase points, the cost will be listed on your loan estimate and closing documents and payable at closing.

Pros and cons of mortgage points

Before making a decision to purchase mortgage points, it’s important to consider both the pros and cons.

Potential savings through mortgage points

If you purchase mortgage points, you could save a lot of money. Here are a few ways that mortgage points could benefit you.

You may save serious money

Because mortgage points allow you to lower the interest rate on your loan, you could save a lot of money. However, because the points will cost you upfront, you will likely need to stay in your home for years before you reach the break-even point.

Lock in a lower monthly payment

Because you’ll be paying a lower interest rate, the interest you pay each month will be less, effectively lowering your monthly mortgage payment.

Tax savings potential

You pay a portion of your mortgage interest upfront when you purchase points. Because mortgage interest is a tax-deductible expense (if you itemize deductions versus taking the standard deduction), the cost of mortgage points can be deducted from your personal tax return.

Calculating savings with mortgage points

Want to see how much mortgage points can reduce the interest on a loan? Take a look at the chart below as we walk through the savings on a $400,000 loan with an interest rate of 6%:

In our example, the borrower could spend $4,000 in points and reduce the total cost over the life of the loan by more than $23,000. Or they could purchase $12,000 worth of points, saving them more than $68,000.

How to calculate the breakeven point?

Before deciding if mortgage points will be worthwhile, you must understand how to calculate the breakeven point. This is when the cost of points equals the amount you’d save in interest.

To figure out the breakeven point, you would need to divide the cost of mortgage points by the savings you’d realize each month. To show you the breakeven point, let’s consider our examples above.

Breakeven point when purchasing one point

$4,000 / $64 = 62.5 months

Breakeven point when purchasing three points

$12,000 / $189 = 63.5 months

If you plan to stay in the house for longer than the breakeven point and keep the same loan terms, paying to lower your interest rate would make sense.

When to buy points on a mortgage

When purchasing points on a mortgage, it makes sense in a few scenarios.

You plan on staying in the house for many years: If you don’t intend to move for many years, buying points could make sense. Remember you want to exceed the breakeven point for it to work out financially.

You’re not planning to refinance anytime soon: With mortgage rates significantly higher than they were a few years ago, buying points might sound like a good idea. However, higher rates might mean you’re more likely to refinance in the near future. Buying points will only make sense if you plan to stay with your current loan and not refinance.

You’re planning to use a down payment of 20% or more: When you make a down payment of 20% or more, you’ll likely receive the best interest rates possible as long as your financials are strong. You’re also going to avoid private mortgage insurance. This is when it would make sense to purchase points.

When not to buy points on a mortgage

There are also some situations where buying points on your mortgage wouldn’t make sense.

You don’t plan to stay in the home for long: If you only plan to stay in the home for a few years, and your breakeven point is seven years, it doesn’t make sense to purchase points. Instead, you could use that money to increase your down payment, which could also help lower your monthly mortgage payment.

You’ll be paying for the points with your down payment: When you buy points on a mortgage, they will be payable at closing. If you don't have the extra money to afford the points and it would be taking away from your down payment, it wouldn’t be worth the cost.

You’re planning to refinance soon: When interest rates are high, you will be more likely to refinance your mortgage when rates drop. If this is the case, buying points now might not make sense. You’ll end up paying the cost for points today and then again in the near future.

TIME Stamp: Points can reduce your monthly payment, but be strategic

If you’re looking for ways to reduce the interest rate and monthly payment on your mortgage, you might consider buying points. While this can be a great strategy for some, it’s important to consider all the factors to understand if it’s your best decision, such as how long you plan to stay in the home.

Frequently asked questions (FAQs)

Mortgage discount points vs. mortgage origination points

Mortgage discount points help home buyers reduce the interest rate and monthly loan payments. These points can be purchased for 1% of the loan value per point.

However, the lender charges mortgage origination points to cover the cost of originating the loan. The amount charged could vary from one lender to another, but the standard cost of origination points is 1.5% of the loan value. Mortgage origination points will be laid out in your closing statement so you know exactly how much you’ll be paying at closing. Depending on your down payment and credit score, some lenders may be willing to negotiate the origination points.

Should you buy down your interest rate as mortgage rates rise?

Buying down your interest rate by purchasing points might be tempting when rates are high. This is going to lower the interest rate you pay on your loan. However, it’s important to remember that if rates drop again, you can refinance. If you refinance too soon after buying points, you most likely won’t pass your breakeven point.

How are mortgage points factored into advertised rates?

When searching for the best mortgage rates online, some lenders will advertise their interest rates and inform you whether those rates include points. For example, Warp Speed Mortgage provides you with a detailed breakdown of how many points the rate includes and what the cost would be. Make sure to check the fine print.

Are mortgage points tax deductible?

The Internal Revenue Service (IRS) classifies mortgage points as mortgage interest. If you itemize your deductions on Schedule A of Form 1040, you should be able to deduct the cost of mortgage points.

Is it worth it to pay points on a mortgage?

When mortgage rates are high, paying for points can be a great way to lower your interest rate. However, it’s important to assess your individual situation to understand if it makes sense financially.