What are mortgage points?
What you’ll learn
What mortgage points are and how they work
How to calculate mortgage points savings
Steps to determining if mortgage points make sense for you
When you buy a home or refinance your mortgage, you pay a certain amount of money upfront. These expenses are known as your closing costs, and they’re due at signing. You also have the option of paying upfront for points, sometimes referred to as discount points.
In exchange for purchasing points, your lender agrees to lower your interest rate. Paying more upfront might seem counterintuitive. But depending on how long you plan to live in your home, you could be saving thousands over the life of your loan. Here’s a quick dive into discount points and how to calculate the impact they can have on the cost of your mortgage.
Mortgage discount points FAQs
What are discount points on a mortgage, and how do they work?
Mortgage points are fees you pay upfront to reduce your mortgage interest rate and, by extension your monthly payment amount. This process is also known as “buying down the rate.” A mortgage point typically costs 1% of the total mortgage amount. Points are paid for upon closing and earn homebuyers a loan interest rate deduction based on the total number of points purchased. You can buy more than one point or even fractions of a point.
Which kinds of mortgage loans allow you to purchase points?
Discount points can be purchased on nearly any type of mortgage, including conforming loans, FHA loans, and jumbo mortgages. If you’re considering an adjustable-rate mortgage (ARM), it’s important to note that discount points generally apply to the initial fixed rate. Be sure to ask your lender how points will apply to your mortgage if you’re considering an ARM.
Can you buy points when refinancing a mortgage?
You can buy mortgage points to reduce your interest rate on both a home purchase and a mortgage refinance. No matter which type of loan you’re applying for, the process for buying down your rate will be the same.
How many points can you buy on a mortgage?
There is no standard limit on the number of discount mortgage points you can purchase. Instead, this limit is set by each lender. At Better Mortgage, the set maximum limit for discount points is 2.5 points per loan.
Pros and cons of using home mortgage points
Mortgage points can help you reduce the cost of your loan, but only if you fully understand the advantages and potential drawbacks. Here’s what you should know before agreeing to pay points.
The benefits of paying points on a mortgage
When you purchase mortgage points, you gain instant access to a lower interest rate. This means a lower monthly mortgage payment, which can help lessen some of the immediate financial strain on your budget and add up to a substantial amount of savings throughout the duration of your loan.
Buying mortgage points can help you maximize the power of your real estate budget; you may even be able to buy a higher-priced home than you originally thought possible by reducing the cost of your monthly payment. Mortgage points may also be tax-deductible (as long as you itemize your returns).
The drawbacks of mortgage loan points
The most obvious drawback to purchasing mortgage loan points is having to pay higher closing costs. Depending on your overall budget for closing costs, the fee for purchasing mortgage points could impact how much money you can afford to allocate toward your down payment.
You’ll want to compare if the savings on your interest rate outweigh the associated costs of carrying a higher loan balance. For example, private mortgage insurance is often required on home loans where the borrower puts less than 20% down.
How to calculate mortgage points
The cost of a mortgage point is equivalent to 1% of the total mortgage amount. So a point for a home loan of $200,000 would be $2,000.
The interest rate deduction you’ll receive in exchange for a point depends on your lender. In most cases, it’s 0.25%. But rates change daily with the market, so it’s important to work with a lender who can offer you the most savings.
Understanding the break-even period
One of the most reliable ways to determine if paying discount points will benefit you is to calculate your break-even point. This calculation will help you determine how long it will take to offset the initial costs of purchasing points.
To calculate your break-even period, divide the total cost of the points by your projected monthly savings.
For instance, let’s say paying $2,000 upfront in points will reduce your monthly payments by $100. In this case, it will take you 20 months (or almost 2 years) for your monthly savings to outweigh those initial costs.
Mortgage points deduction examples
Let’s take a more in-depth look at how the math of mortgage points works in the long-term. :
Say you’re applying for a $300,000 mortgage with a 4% interest rate, which will result in a monthly payment of $1,432. However, your lender tells you if you pay $9,000 in points upfront, you can decrease your interest rate to 3.25%. This will reduce your mortgage payments to $1,306 per month — a monthly saving of $126.
Seems like you should purchase the points, right? But in order to truly determine if that makes sense for you, calculate your break-even point. You can do that by dividing the upfront cost of $9,000 by your monthly savings of $126 (9,000/126=71.4), which confirms that it will take nearly 72 months — or almost 6 years — before the long-term savings start taking effect.
If you plan to move or refinance your mortgage before that time, then you’ll never truly recoup your upfront payment. But if you plan to stay in your mortgage long-term, your savings will far outweigh the costs you paid to reduce your interest rate upfront.
In fact, over the course of your 30-year mortgage, you’ll save more than $36,000!
Running your own numbers? Use our loan comparison calculator for fast answers.
Points vs credits: What's the difference?
When you apply for a mortgage, you may also have the option to “take credits.” Credits are the opposite of points.
When you take credits as a homebuyer, you accept a higher interest rate in exchange for the lender lowering closing costs (or even paying them off completely). This can be an attractive option for borrowers who want to spend less money upfront.
With points, you pay more at closing to get a lower interest rate. But with credits, you pay higher interest rates throughout the life of your loan while saving money in the short term. (And in some scenarios, credits can save you more than points.) Choosing to take either points or credits depends on your personal priorities and your homebuying budget.
Are mortgage points worth it?
Mortgage points aren’t ideal for every homebuyer or homeowner, but here are 2 examples of general scenarios where purchasing discount mortgage points might be financially advantageous.
- I plan on living in my home for a long time.
The longer you plan to stay in your home, the more sense it makes to purchase mortgage points. In other words, paying points can be well worth it if you’re planning to buy your forever home.
On the other hand, if you plan to upgrade, downsize, or need to relocate in the near future, then you may be better off keeping more money in your pocket at closing and paying higher monthly payments for a short time period.
Remember, determining your exact break-even point can help you decide if paying points is worth it, given your timeframe and homebuying priorities
- I’m making a 20% (or less) down payment on my mortgage.
If you’re putting less than 20% down on a conventional loan, you’ll likely have to roll the cost of private mortgage insurance (PMI) into your monthly payment. PMI can add up to an annual expense of several thousand dollars (and quickly cancel out any savings from purchasing points).
If you’re trying to decide between buying points or putting more cash toward a larger down payment (and getting past that 20% cutoff), a larger down payment will most likely save you more money in the long run.
Better Mortgage can point the way
The decision to purchase mortgage points depends on several factors, including the types of loans and interest rates available to you. If you’re unsure whether purchasing mortgage points is the right move for you as a homebuyer, getting pre-approved can help clarify your budget and see details about your loan options. At Better Mortgage, you can get pre-approved in as little as 3 minutes.