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What Are Mortgage Points & How Do They Work? [With Advanced Tips!]

There’s a lot that goes into buying a home and securing a mortgage, including looking into interest rates and determining down payments. Along the way, you may have heard of something called mortgage points — but what are they, and are they right for you? In this comprehensive guide, we’ll explain their benefits, provide examples and tips, and help you determine whether mortgage points make sense for you and your situation.

What Are Mortgage Points?

Mortgage points, also referred to as mortgage discount points, are optional fees that you pay to a lender at closing in exchange for a reduced interest rate on your home loan. Not only can purchasing mortgage points lower your monthly mortgage payment when interest rates are high, you can also potentially save thousands of dollars over the life of your loan.

In general, each mortgage point costs one percent of your borrowed amount and subtracts 0.25% from your interest rate. [1] For example, let’s say you have a $400,000 mortgage with a rate of 6% and you choose to buy one mortgage point. The cost for that point would be $4,000 and it would reduce your interest rate to 5.75% for the life of the loan.

It’s important to keep in mind that each mortgage point you buy must be paid upfront.

How Do Mortgage Points Work?

The idea behind mortgage discount points is that you pay some interest up front in exchange for a lower interest rate over the life of your loan. In most cases, one discount point lowers your mortgage interest rate by one-quarter of a percent. This number will depend on your mortgage lender, so it’s in your best interest to get confirmation before making any final decisions.

The number of points you purchase is up to you, and it may be possible to purchase a fraction of a point. [1] Using the same example as above, choosing to purchase a half point would cost $2,000 and reduce your interest rate to 5.875%.

Benefits of Mortgage Points

The main benefit of mortgage points is that you’ll receive a lower interest rate over the life of your loan. But that’s not the only potential positive. Here are some additional pros of purchasing mortgage discount points:

  • They come with potential tax benefits. Mortgage points are tax deductible, but only in the year you pay them. [2]
  • You can save a significant amount of money. Paying more upfront can reduce the amount you’ll pay over the life of your mortgage, especially if you plan on staying in the home long term.

Drawbacks of Mortgage Points

While there are compelling reasons to consider buying mortgage points, it’s also important to factor potential drawbacks into your decision. These include:

  • The initial expense. As we mentioned previously, mortgage points must be paid upfront. Depending on your mortgage amount and how many you buy, this could add a significant amount to your closing costs.
  • You might not save as much as you expect. You’ll only reap the benefits of your investment once the amount you save from your reduced interest rate surpasses the amount you paid for your mortgage points. This means that if you plan to sell or refinance before this occurs (also known as the “break-even point” — more on that later), purchasing mortgage points won’t provide any financial benefit.

How Much Can You Save by Buying Mortgage Points?

Provided you plan to remain in your home for an amount of time that makes purchasing mortgage points worthwhile, the question remains — how much will you save? Take a look at the chart below for examples of how your savings could stack up:

Number of Points Interest Rate Cost of Points Monthly Loan Payment Total Savings
0 6% $0 $2,398 N/A
.5 5.875% $2,000 $2,366 $11,520
1 5.75% $4,000 $2,334 $23,040
2 5.5% $8,000 $2,271 $45,720

Please note: This chart is based on a 30-year fixed, $400,000 mortgage. Points are valued at 1% of the loan amount with each reducing the interest rate by 0.25%.

Are Mortgage Points Right for You?

There are several factors to consider when it comes to mortgage points.

When To Buy Points on a Mortgage

Buying mortgage points may be worthwhile if:

  • You’re planning to stay in your home past the break-even point.
  • You choose a fixed-rate mortgage.
  • You have enough cash on hand to afford the extra cost up front (in addition to your down payment and closing costs).
  • It’s a buyer’s market. In the right market conditions, it isn’t unheard of for sellers to offer to pay the cost of a buyer’s mortgage points, enabling savings without the need to worry about the break-even point. [3]

When Not To Buy Points on a Mortgage

On the other hand, buying mortgage points may not be the right decision if:

  • You’re planning to sell or refinance your home before the break-even point.
  • You aim to pay off your home loan early. Mortgage points offer the most financial benefit when paying over the full loan term.
  • You opt for an adjustable-rate mortgage, as this would only provide savings during the initial period. [4]
  • You can’t afford to pay thousands of extra dollars on top of your closing expenses and down payment.

What Is the Break-Even Point?

This refers to the point in time at which the amount you save surpasses the total you spent to purchase points. The longer you stay in your home past this point, the more you will financially benefit from the points you purchased.

To calculate your break-even point, follow this simple formula:

Break-even point = total point cost / monthly savings [5]

If we continue with our example, the break-even point for a $400,000 mortgage, where a homeowner spends $4,000 for one point (representing $32 in monthly savings) would be 125 months, or just under 10.5 years.

Discount Points vs. Origination Points

As you navigate the homebuying process, you may also come across origination points. It’s crucial to understand that these are not the same as mortgage discount points. While mortgage points impact your interest rate, origination points are essentially a fee that a lender charges to cover the cost of processing your loan. [6]

Frequently Asked Questions

Q: Is it worth it to buy points on a mortgage?
A: Maybe — it just depends on your situation. Do you have available cash up front to purchase mortgage points? Are you planning on staying in your home for a substantial amount of time? If the answer is yes to those questions, you may want to consider purchasing points to reduce the interest rate over the life of your loan.

Q: How many points can I buy?
A: There is not a fixed maximum, but there are state and federal regulations in place to make sure a borrower doesn’t overpay to the point where the cost of the points outweighs the benefit of the lower rate.

Q: Is there a standard rate reduction for buying points?
A: Typically, one point costs 1% of your mortgage amount. For example, if your loan amount is $400,000, one point would cost you $4,000 at the time of closing.

Q: How do points work if I have an Adjustable Rate Mortgage?
A: At the end of the fixed Adjustable Rate Mortgage (ARM) period, the rate will adjust. Usually, the mortgage points line up with the initial fixed rate.

Q: Are mortgage points negotiable?
A: Points are not negotiable. Each lender has a specific rate discount associated with the points being paid.

Q: What’s the difference between mortgage points and origination points?
A: While mortgage points impact your interest rate, origination points are essentially a fee that a lender charges to cover the cost of processing your loan.

Q: How can I determine the break-even point for my mortgage?
A: To calculate your break-even point (or how long it takes for your savings to surpass your initial mortgage point investment), divide the total cost of your points by the amount you save on your loan payment each month.

Interested in Mortgage Points?

If you’re interested in learning more about mortgage points, or think they may be right for you, we encourage you to talk to a mortgage specialist. With decades of collective mortgage industry experience, Blue Water Mortgage brokers have the expertise to help you make an informed decision. Contact us today to set up a free call and get started.

 

Article Sources

Blue Water Mortgage requires writers to use reliable primary sources, such as white papers, government data, and expert interviews, to produce accurate and unbiased content. We follow strict editorial policies and refer to original research from reputable publishers when necessary.

1. Bankrate. “Mortgage points: What are they and how do they work? https://www.bankrate.com/mortgages/mortgage-points/

2. IRS. “Topic no. 504, Home mortgage points, https://www.irs.gov/taxtopics/tc504

3. NerdWallet. “Mortgage Points: Should You Pay These Optional Fees?, https://www.nerdwallet.com/article/mortgages/discount-points

4. U.S. Bank. “What are mortgage points and how do they work?, https://www.usbank.com/home-loans/mortgage/first-time-home-buyers/mortgage-points.html

5. NerdWallet. “Mortgage Points Calculator, https://www.nerdwallet.com/article/mortgages/should-i-buy-points-mortgage-calculator

6. Investopedia. “Origination Points: Meaning, Examples in Mortgages, https://www.investopedia.com/terms/o/originationpoints.asp

Roger Odoardi

Roger is an owner and licensed Loan Officer at Blue Water Mortgage. He graduated from the University of New Hampshire’s Whittemore School of Business and has been a leader in the mortgage industry for over 20 years. Roger has personally originated over 2500 residential loans and is considered to be in the top 1% of NH Loan Officers by leading national lender United Wholesale Mortgage.