What are mortgage points?
When you take out a mortgage, whether it’s to buy a house or refinance an existing home loan, it’s likely the lender will charge you “points.”
A point is a fee equal to 1 percent of the mortgage amount.
For example, if you buy a house and need a mortgage of $160,000, 1 point would cost you $1,600.
A lender can charge 1 point, several points or no points at all. Points don’t always have to be round numbers. A lender might charge 1.5 points, which would be $3,000 on a $200,000 mortgage.
The points are listed on the Loan Estimate, a document you get soon after you apply for a mortgage that summarizes the details of the loan offer. Points are also itemized on the Closing Disclosure, a form you get before settlement that provides the final mortgage terms. Points are paid at closing.
There are essentially two kinds of mortgage points: discount points and origination points.
What are discount points?
Discount points are actually prepaid interest on the mortgage loan. The more points you pay, the lower the interest rate on the loan.
Paying points is often referred to as “buying down the rate.” A loan with no points will have a higher interest rate than a loan with 1 point.
Borrowers usually can pay from zero to several points, depending on how much they want to reduce their rate. Every mortgage lender has its own price structure, so how much you can lower your rate by paying points depends on the lender, the type of loan and the mortgage market.
Generally, though, each point you pay will lower your interest rate by one-eighth to one-quarter of a percent.
Use our mortgage calculator to figure out your monthly payments.
What are origination points?
Origination points cover the lender’s cost of processing the loan. They’re a way to pay closing costs – and, they’re negotiable. The number of origination points lenders charge varies, so be sure to ask about them when you are shopping for a mortgage lender.
Also, lenders may use different terms for points. They may call them “maximum loan charges” or “loan discounts.” If you’re confused, ask your lender for clarification.
When is it worth it to buy points?
Deciding whether to pay mortgage points depends largely on two factors:
- How long you plan to stay in the home.
- How much money you have to put down at closing.
If you are planning to move or refinance in a few years, paying points is probably not a good move.
“Buying down your interest rate through discount points is a financial decision that looks better the longer you own the home,” says Greg McBride, CFA, Bankrate’s chief financial analyst.
“The upfront payment of points translates into a permanently lower monthly mortgage payment, so the longer you benefit from those lower payments, the better return on investment you get from paying points.”
If you need your closing costs to be as low as possible, choose the zero-points option on your loan program.
Do the math
Let’s say you get a 30-year fixed-rate mortgage for $200,000 at 5.5 percent interest with no points. The monthly principal and interest payment would be $1,136.
If you pay 2 discount points at closing, or $4,000, and your rate is reduced to 5 percent, your monthly payment would be $1,074, a reduction of $62 per month.
It would take almost five and a half years to get back the $4,000 you paid upfront on discount points (4,000 / 62 = 64.5 months).
If you own the house for more than 64.5 months, you will have saved money by paying the points.
If you don’t pay cash for points at closing, you might be able to finance them and roll them into your loan. Let’s say you get a 30-year, fixed-rate mortgage for $150,000 at 6 percent. You can pay 2 points ($3,000) to get a rate of 5.5 percent, or you can opt for zero points and pay the 6 percent.
Monthly principal and interest payments on 5.5 percent would be $852; monthly payments on 6 percent would be $899. You cut the monthly payment by $47 if you buy the points, but you increase your loan amount to $153,000 by financing them.
Nevertheless, buying those points would save you $17,151 in interest over the life of the loan if you stay in the house.
Use Bankrate’s mortgage calculator to figure your monthly payment and see how much interest you’ll pay over the life of the loan.
If you’re not sure how long you’ll stay in the home or if you’ll refinance, ask your loan officer to calculate your costs over different lengths of time.
Are points tax-deductible?
Discount points are deductible as mortgage interest on a primary residence or on a second home that is being rented out, but there are restrictions:
- The mortgage must be obtained to buy, build or improve the home and the home is the collateral for the loan.
- The money to buy the points must be paid directly to the lender and not borrowed.
- Origination points are not tax-deductible on non-rental properties.
- If you pay points to refinance a mortgage, you’ll likely have to spread out the deduction over the loan term.
Ask a tax adviser if you have questions about the deductibility of mortgage points and interest.