Buying a house is expensive, and that’s before you add in lender fees and interest payments. One way you can reduce the cost is by purchasing optional mortgage points from your lender. These fees prepay interest and let you lock in a lower interest rate. By buying down your rate, you can decrease the total cost of your loan.
What are points on a mortgage?
Mortgage points, or discount points, are an optional add-on to your mortgage. Buying points reduces your interest rate, which in turn lowers both your monthly payments and long-term loan costs.
How do mortgage points work?
Lenders price discount points as a percentage of your mortgage amount. Each point you buy lowers your interest rate by a set amount.
While the numbers vary between lenders, generally, one point costs 1% of your total loan amount and lowers your interest rate by 0.25%. Lenders may also let you purchase fractions of a point, such as half of a point or a quarter of a point, to see some savings.
How can mortgage loan points cut interest costs?
Let’s explore how mortgage points reduce interest rates. For our example, we’ll assume a $200,000 mortgage with a 30-year loan term and 4% base interest rate.
| Loan Principle | $200,000 | $200,000 | $200,000 |
| Discount Points | 0 | 1 | 2 |
| Interest Rate | 4.0% | 3.75% | 3.5% |
| Monthly Payment | $954.83 | $926.23 | $898.09 |
| Interest Total | $143,739.01 | $133,443.23 | $123.312.18 |
| Lifetime Savings | $0 | $10,295.78 | $20,426.83 |
When do you break even with mortgage points?
Whether or not you should buy discount points depends on when you break even. The premise of breaking even is simple. When your monthly savings add up to the cost of your upfront fee, you’ve reached the breakeven point.
After that, you start seeing savings on your mortgage. But if you sell or refinance before this point, you actually lose money paying for discount points. The breakeven point varies based on your loan size, term, and interest rate.
You can calculate your break even point in months by dividing the cost of discount points by your monthly savings. Let’s use our example from above. Say that you borrow $200,000 on a 30-year term.
Originally, your interest rate was 4% with a monthly payment of $954.83. However, you decide to buy two discount points worth $2,000 apiece, which is $4,000 total, to get a 0.5% rate reduction. This will lower your monthly payment to $898.09, saving you $56.74 per month.
To find your breakeven point, you simply divide $4,000 by $56.74, which gives you 70.5 months. In other words, it would take you just under 6 years to break even and start seeing savings on your mortgage.
Are mortgage points worth it?
Mortgage points aren’t cheap, but they may be worth it if the following is true:
- You plan to stay in your home for a long time. The longer you’re in your home, the more you’ll pay on your mortgage. Since discount points represent long-term savings, they’re most beneficial if you plan to stick around.
- You know your breakeven point. It’s important to calculate the point at which your long-term savings eclipse the upfront cost of buying mortgage points. If you don’t stay until then, buying points can actually cost more.
When should you not buy mortgage points?
That said, buying mortgage points may not make sense if the following is true:
- You’re not staying long. The less time you pay your mortgage, the less your points benefit you.
- You’re going to pay extra on your mortgage. Discount points reduce your interest rate, not your principal. If you plan to aggressively pay down your loan, you won’t see the long-term savings that discount points offer.
- You don’t have the money. You shouldn’t put yourself into a financial bind to save on interest – especially if doing so would jeopardize your ability to make your mortgage payments.
- Your down payment will suffer. Your down payment size affects your interest rate, potential loan terms, and PMI. If you use part of your down payment to buy mortgage points, you may, ironically, increase your mortgage costs.
Do mortgage points affect taxes?
Mortgage points count as prepaid interest toward your loan. As such, you may be able to deduct some or all of your mortgage loan point costs under federal tax laws. You may want to consult a tax professional to see if buying discount points can help you save.
Can you buy mortgage points after closing?
Mortgage points impact your interest rate, which is set in stone before you close on your mortgage. In other words, you cannot buy mortgage points after closing. Unless you refinance, points can’t be bought after closing.
Mortgage discount points vs APR
A loan’s APR reflects how much the loan costs, including the interest rate and any applicable lender fees. Comparing APRs from different lenders is one way to decide which has the best terms when rate shopping.
By contrast, discount points are effectively prepaid interest. If you buy discount points, you may notice that your loan’s APR goes down, because the cost to borrow money decreases.
Mortgage points can save you money long-term
While mortgage points can cost thousands of dollars upfront, they can save you far more than that in long-term interest payments. But before you buy any discount points, you’ll want to determine your breakeven point and long-term life plans. If you won’t stay in the home long enough to reap the benefits, they may be a waste of money.
FAQ
What are points on a mortgage?
Mortgage points are optional fees that reduce your loan’s interest rate. Generally, one point costs 1% of your loan amount and reduces your interest rate by 0.25%.
How much does 1 point lower your interest rate?
Generally, one mortgage point lowers your interest rate by 0.25%. However, lenders set their own terms, so the conversion may vary.
Is origination fee the same as points?
No. Your origination fee is the cost the lender charges to originate your mortgage. Mortgage loan points are an optional add-on that reduces your interest rate.
