Mortgage points are an optional fee you can pay your lender at closing; this fee will lower your interest rate for the life of your loan. Paying points, or buying down your rate, will reduce your monthly payment and might save you thousands of dollars over the life of your loan.
That doesn’t mean it always makes sense to pay them. First, we’ll talk about how mortgage points work. Then, we’ll show you how to tell when a rate buydown might be a smart move.
What are points on a mortgage and how do they work?
Mortgage points are prepaid interest. One point is equal to 1% of the amount you’re borrowing. If you’re getting a mortgage for $350,000, one point would cost you $3,500. You can look at points as paying interest now instead of paying interest later.
You don’t have to pay a round number of points, such as one point or two points. You can pay 1.25 points, 2.875 points, or any amount that your lender agrees to.
You might think that paying one point would lower your interest rate by 1 percentage point — from 7% to 6%, for example. That’s not the case.
The interest-rate savings you could see from paying points depend on three factors:
- Market conditions
- Loan type
- Lender
The rate reduction a lender offers you might be 0.25 percentage points, reducing a 7% rate to 6.75%. It might be 1.25 percentage points, reducing a 7% rate to 5.75%. It could be any amount the lender’s guidelines allow for.
Discount points vs. origination points
There are two types of mortgage points: discount points and origination points. Both compensate the lender.
- Discount points lower your interest rate.
- Origination points are for processing your application and underwriting your loan.
Tip
Don’t confuse discount points and origination points with basis points. You’ll come across the term “basis points” in financial reporting about mortgage rates. One basis point is 1/100th of a percentage point.
How much money you’ll save when you buy mortgage points
The best way to understand how much you could save by paying discount points is to do some math. You’ll need a mortgage calculator, a simple spreadsheet, and the numbers that apply to your own situation. Here’s an example.
How points work on a 30-year fixed-rate mortgage
As the table shows, the longer you keep your loan and the less you pay for points, the more likely you are to save money by paying points.
Most people don’t keep their mortgages for the full 30 years, however. In fact, a recent study shows that the average U.S. home switches owners every 12 years. Homeowners end up moving or refinancing sooner for reasons they may not have predicted: death, divorce, job opportunities, marriage. Also, people occasionally pay off their mortgages early.
Keep these possibilities in mind when deciding whether paying points is right for you — and how many points to pay.
Tip
If you roll your points into your loan instead of paying for them in cash at closing, you’ll be paying interest on them, and it will take longer to come out ahead.
When you should or shouldn’t buy mortgage points
Everyone’s circumstances are different, but here are a few situations where it could be a good or bad idea to pay discount points on a mortgage loan.
Good idea
- Points are cheap. Do an analysis like we showed in the table above. If your break-even period is short, paying points could be a sweet deal.
- You’re buying or refinancing your forever home. The longer you have your mortgage, the more you’re likely to save by paying points.
- You don’t want to worry about refinancing to a lower rate in the future. You may not want to take a chance on what could happen with world events, the financial markets, or your financial circumstances. Paying points is a bird in the hand.
- You can comfortably pay more at closing. As a homeowner, it’s extra important to have plenty of cash available for emergencies. Putting your savings in a precarious position to lower your rate might not be a smart trade-off for many buyers, but it might be a good call if you have the funds available.
Bad idea
- Points are expensive. The mortgage rate reduction you get for paying points might not be worth it.
- You aren’t sure how long you’ll live in your current home. The less time you have on your mortgage, the less likely it is that you will come out ahead by paying points.
- Do you think refinancing in the future could be a better option than paying points now? No one can predict the future, but it’s possible that market rates could decrease or that your financial situation could improve, allowing you to get a better interest rate in a year or two.
- You haven’t gotten loan estimates from multiple lenders. You might have to pay points with one lender to get the same rate another lender would give you without charging you points. Check out the best home loan lenders for your situation.
- Rates are trending down. It might make more sense to float your rate for now until you’re closer to closing. You may be able to lock in a lower rate without paying points. (But rates could go up during that time, too.)
Mortgage points FAQ
How much is one mortgage point worth?
One mortgage point, also called a discount point, is equal to 1 percent of the loan amount. If you were borrowing $400,000, one point would cost you $4,000.
However, paying one discount point generally will not lower your mortgage rate by one percentage point; it will lower it by a greater or lesser amount. For example, it might lower your rate by 0.25 percentage points, from 7.50% to 7.25%.
Are mortgage points tax deductible?
If you itemize your deductions on your tax return instead of claiming the standard deduction, you may be able to deduct your points as prepaid mortgage interest.
How much money do mortgage points save me?
One point always costs you, the borrower, 1 percent of the loan amount. The amount it reduces your rate depends on market conditions, loan type, and lender guidelines. Mortgage points may or may not save you money, depending on how much you pay for them and how long you keep your mortgage.
Is there a limit on the number of mortgage points I can buy?
If you’re getting a qualified mortgage, there’s a limit on how many mortgage points you can buy. The Consumer Financial Protection Bureau limits lender fees on these loans. Most mortgages are qualified mortgages.
If you aren’t getting a qualified mortgage, the limit is based on what you can afford. Your lender determines what you can afford using the federal ability-to-repay rule.
There’s also a limit on how many points you would want to pay from a cost-benefit standpoint. You might not end up with monthly interest savings that are enough to offset the upfront cost of buying a lot of points. If you refinance or sell sooner than you expected, you could end up losing money by paying points.
Do I have to buy a minimum amount of mortgage points?
No, you don’t have to buy a minimum amount of mortgage points. You don’t have to buy any points at all. You can even choose the opposite of mortgage points: lender credits. These allow you to lower your closing costs in exchange for paying a higher interest rate.
