Portions of this article were drafted using an in-house natural language generation platform. The article was reviewed, fact-checked and edited by our editorial staff.
Key takeaways
- Mortgage points are upfront fees you can pay your mortgage lender in exchange for a lower interest rate.
- It's important to calculate the breakeven point before buying mortgage points to determine if it will save you money in the long run.
When purchasing a home, there are many factors to consider, including the type of mortgage you want and the interest rate you’ll pay. One option you can consider is buying mortgage points to lower your interest rate. But what exactly are mortgage points and how do they work? In this article, we’ll dive into the details of mortgage points, including their benefits and drawbacks and how to calculate the breakeven point.
What are mortgage points?
Mortgage points are the fees a borrower pays a mortgage lender to get a lower interest rate on their loan. Doing so lowers the overall amount of interest they pay over the mortgage term. This practice is sometimes called “buying down the interest rate.”
Each point the borrower buys costs 1 percent of the mortgage amount. So, one point on a $300,000 mortgage would cost $3,000.
In effect, mortgage points are a type of prepaid interest. By buying these points, you reduce the interest rate of your loan, typically by 0.25 percent per point. You can often buy a fraction of a point or up to as many as three whole points — sometimes even more.
By reducing the loan’s interest rate, you can lower your monthly payment. However, keep in mind that this requires an upfront payment. Typically, the longer you plan to live in a home, the more benefit you’ll get from paying for points.
Discount points vs. origination points
Mortgage points that lower your interest rate, also known as “discount points,” are not to be confused with origination points — another type of mortgage point.
Origination points don’t affect the interest rate on your loan, and they are not discretionary, but mandatory. They are origination fees a lender charges to create, review and process your loan. Like its discount cousin, one origination point typically equals 1 percent of the total mortgage. So, if a lender charges 1.5 origination points on a $250,000 mortgage, the borrower must pay $3,750. Typically, you pay your origination points as part of your closing costs when you finalize your home purchase.
Not all lenders charge origination points on their mortgages. Some lenders allow borrowers to get a loan with no- or reduced-closing costs or origination points; however, they often compensate for that with higher interest rates or other fees.
You can also sometimes negotiate origination points. Homebuyers who come to the table with a 20 percent down payment and a strong credit score have the most significant negotiating power, as lenders will reduce origination points to entice well-qualified buyers.
How do mortgage points work?
Each mortgage discount point typically lowers your loan’s interest rate by 0.25 percent, so one point would lower a mortgage rate of 6.5 percent to 6.25 percent for the life of the loan. How much each point lowers the rate varies among lenders, however.
The rate-reducing power of mortgage points also depends on the type of mortgage loan and the overall interest rate environment. When you explore buying points, mortgage lenders should tell you the specifics.
Borrowers can buy more than one point, and even fractions of a point. A half-point on a $300,000 mortgage, for example, would cost $1,500 and lower the mortgage rate by about 0.125 percent.
You’ll pay for the points at closing, and they’re listed on the loan estimate document, which you’ll receive after applying for a mortgage, and the closing disclosure, which you’ll receive a few days before closing the loan.
Benefits and drawbacks of mortgage points
Mortgage points, or discount points, offer both benefits and drawbacks that you need to consider before deciding to purchase them. Here’s a closer look at the pros and cons of mortgage points:
Pros of mortgage points
- Lower interest rates: By purchasing mortgage points, you’re lowering the interest rate on your mortgage, which leads to reduced monthly payments and less total interest over the loan term.
- Tax deductions: The IRS allows homeowners to deduct the cost of mortgage points from their annual tax returns, which can lead to significant savings.
Cons of mortgage points
- Upfront cost: Mortgage points require an upfront payment at closing. This increases the initial cost of your mortgage.
- Might not always save you money: The benefits of mortgage points only kick in after the savings from the lower interest rate surpass the cost of the points — known as the breakeven point. If you sell or refinance your home before this point, you won’t realize the financial benefit of the points.
How much can you save by paying mortgage points?
If you can afford to buy discount points on top of the down payment and closing costs, you will lower your monthly mortgage payments and could save lots of money. The key is staying in the home long enough to recoup the prepaid interest. As we mentioned before, if you sell the home after only a few years, or refinance the mortgage or pay it off, buying discount points could lose you money.
Here’s an example of how discount points can reduce costs on a $320,000, 30-year, fixed-rate mortgage with 20 percent down:
| Loan principal: $320,000 | Without points | With points |
|---|---|---|
| Interest rate | 7.0% | 6.5% |
| Discount points cost | $0 | $6,400 |
| Monthly payment (principal and interest) | $1,703 | $1,618 |
| Lifetime total interest paid | $357,293 | $326,584 |
| Lifetime savings | N/A | $30,709 |
In this example, the borrower bought two discount points, with each costing 1 percent of the loan principal, or $3,200. By buying two points for $6,400 upfront, the borrower’s interest rate shrank to 6.5 percent, lowering their monthly payment by $85, and saving them $30,709 in interest over the life of the loan. (However, to save that full amount, the borrower would have to live in the home for the full term of the loan — 30 years — and never refinance.)
How to calculate the breakeven point
To calculate the “breakeven point” at which you’d recover your outlay on the prepaid interest, divide the cost of the mortgage points by the amount the reduced rate saves each month. Using the example above:
Breakeven calculation
$6,400 / $85 = 75 months
This shows that our borrower would have to stay in the home for about 75 months, or just over six years, to recover the cost of the discount points.
You can use Bankrate’s mortgage points calculator and amortization calculator to figure out whether buying mortgage points will save you money.
Should you buy down your interest rate with points?
Buying mortgage points makes the most sense in a few cases:
- If you plan to be in the home for a long time: Because buying points on mortgages reduces the rate for the life of the loan, every dollar you spend on points goes further the longer you pay that mortgage. As a result, if you plan to be in the house for years to come, the amount you’ll save each month is likely to make the upfront cost worth it.
- You’re already putting 20 percent down: With a 20 percent down payment, you’re avoiding private mortgage insurance (PMI) and likely getting the best interest rate the lender can offer you. If you haven’t hit the 20 percent mark on the down payment, though, putting money there rather than into points will likely still lower your interest rate, and possibly by a larger margin. That’s because a bigger down payment lowers your loan-to-value ratio, or LTV, which is the size of your mortgage compared with the value of the home.
- You don’t plan to refinance anytime soon: Even if you plan to stay in the house for a while, the current environment of relatively high interest rates may have you considering a refi down the road. Refinancing will change your mortgage interest rate, so if you think that could be in your future, buying mortgage points now might not be the right choice for you.
I’m ambivalent about paying points — it strikes me as a lot of extra analysis without a big reward. But, if it’s very important to you to lower the rate over the life of your loan, and you have cash on hand to make it work, go ahead. Just make sure you’ll keep the mortgage long enough to recoup the upfront costs.— Jeff Ostrowski, Principal Writer, Bankrate
How to compare mortgage loan offers
Looking at the annual percentage rate (APR) of your mortgage can help you compare loans with different rates and point combinations. The APR incorporates not just the interest rate, but also the points you pay and any fees the lender will charge, so it can give you more clarity and help you compare quotes more easily.
Once you get a quote from a lender, run the numbers to see if it’s worth paying points to lower the rate for the length of your loan.
FAQ on mortgage points
Mortgage rates remain elevated, which might make mortgage points seem more attractive to many borrowers. However, the breakeven point remains five-plus years. In other words, the benefits of paying points will only be realized if you expect to have the loan longer than five years.
Whether you find a rate on a mortgage lender’s website or through a third party, the mortgage rates you see advertised might or might not include points. One rate might even seem attractively low, but that could be due to points already factored in that you might not want to pay. So be sure to check the listing’s fine print.
Mortgage discount points are tax-deductible on up to $750,000 of mortgage debt for homeowners who bought property after Dec. 15, 2017, or up to $1 million for those who purchased before that date. Origination points are not tax-deductible, as they’re considered charges for services, not homebuying expenses.
