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Buying a house is the most expensive purchase most of us will ever make, so naturally, anything that can reduce the cost of a mortgage is worth looking at. Besides negotiating a good price and shopping for the best mortgage rates, some homebuyers buy mortgage points.
So, what are mortgage points? Also called “discount points,” they’re basically a way to lower your interest rate — for a fee.
Let’s look more closely at mortgage points, how they work, and when it’s smart to use them.
What are points on a mortgage?
Mortgage points are the fees a borrower pays a mortgage lender in order to trim the interest rate on the loan, thus lowering the overall amount of interest they pay over the mortgage term. This practice is sometimes called “buying down the rate.”
Each point the borrower buys costs 1 percent of the mortgage amount. So, one point on a $300,000 mortgage would cost $3,000.
In effect, mortgage points are a type of prepaid interest. By buying these points, you reduce the interest rate of your loan, typically by 0.25 percent per point. You can often buy a fraction of a point or up to as many as three whole points — sometimes even more.
By reducing the loan’s interest rate, you can lower your monthly payment. However, keep in mind that this requires an upfront payment. Typically, the longer you plan to live in a home, the more benefit you’ll get from paying for points. To get a feel for how much your mortgage rate’s points could save you, use this calculator.
Discount points vs origination points
Mortgage points that lower your interest rate, aka “discount points,” are not to be confused with origination points — another type of mortgage point.
Origination points don’t affect the interest rate on your loan, and they are not discretionary, but mandatory. They are fees charged by a lender to originate, review and process your loan. Like its discount cousin, one origination point typically equals 1 percent of the total mortgage. So, if a lender charges 1.5 origination points on a $250,000 mortgage, the borrower must pay $4,125. Typically, you pay your origination points as part of your closing costs, when you finalize your home purchase.
Not all lenders charge origination points on their mortgages. Some lenders allow borrowers to get a loan with no- or reduced closing costs or origination points; however, they often compensate for that with higher interest rates or other fees.
How do mortgage points work?
Each mortgage discount point typically lowers your loan’s interest rate by 0.25 percent, so one point would lower a mortgage rate of 4 percent to 3.75 percent for the life of the loan. How much each point lowers the rate varies among lenders, however. The rate-reducing power of mortgage points also depends on the type of mortgage loan and the overall interest rate environment. When you explore buying points, mortgage lenders should tell you the specifics.
Borrowers can buy more than one point, and even fractions of a point. A half-point on a $300,000 mortgage, for example, would cost $1,500 and lower the mortgage rate by about 0.125 percent.
The points are paid at closing and listed on the loan estimate document, which borrowers receive after they apply for a mortgage, and the closing disclosure, which borrowers receive before the closing of the loan.
Should you buy points on a mortgage?
Buying mortgage points is a way to pay upfront to lower the overall cost of your loan and reduce its monthly payment. It makes the most sense in a few cases:
- If you plan to be in the home for a long period of time. Because buying points on mortgage loans reduces the rate for the life of the loan, every dollar you spend on points goes further the longer you pay that mortgage. As a result, if you plan to be in the house for a while, the amount you’ll save each month is likely to make the upfront cost worth it. (Conversely, if you don’t plan to stay in a home for a long time, paying points is likely to lose you money overall.)
- You’re already putting 20 percent down. If you are, you’re avoiding private mortgage insurance (PMI) and likely getting the best interest rate the lender can offer you. If you haven’t hit the 20 percent mark on the down payment, though, putting money there rather than into points will likely still lower your interest rate, and possibly by a larger margin. That’s because bigger down payment lowers your loan-to-value ratio, or LTV, which is the size of your mortgage compared with the value of the home.
- You don’t plan to refinance anytime soon. Even if you plan to stay in the house for a while, the current environment of relatively high interest rates may have you considering a refi down the road. Refinancing will change your mortgage interest rate, so if you think that could be in your future, it may be prudent to skip buying points mortgage-wise now.
Ultimately, borrowers should consider all the factors that could determine how long they plan to stay in the home with that mortgage — such as the size and location of the property, their job situation and the current mortgage rate environment — then figure out how long it would take them to break even before buying mortgage points.
Example: How mortgage points can cut interest costs
If you can afford to buy discount points on top of the down payment and closing costs, you will lower your monthly mortgage payments and could save lots of money. The key is staying in the home long enough to recoup the prepaid interest. As we mentioned before, if you sell the home after only a few years, or refinance the mortgage or pay it off, buying discount points could be a money-loser.
Here is an example of how discount points can reduce costs on a $400,000, 30-year, fixed-rate mortgage with 20 percent down:
|Monthly payment (principal and interest)||$2,022||$1,918|
In this example, the borrower bought two discount points, with each costing 1 percent of the loan principal, or $3,200. By buying two points for $6,400 upfront, the borrower’s interest rate shrank to 6 percent, lowering their monthly payment by $104, and saving them $37,559 in interest over the life of the loan. (However, to save that full amount, the borrower would have to live in the home for the full term of the loan, 30 years, and never refinance.)
What is the breakeven point?
To calculate the “breakeven point” at which this borrower will recover what was spent on prepaid interest, divide the cost of the mortgage points by the amount the reduced rate saves each month:
$6,400 / $104 = 61.5 months
This shows that the borrower would have to stay in the home just over 61 months, or roughly five years, to recover the cost of the discount points.
“The added cost of mortgage points to lower your interest rate makes sense if you plan to keep the home for a long period of time,” says Jackie Boies, a senior director of Partner Relations for Money Management International, a nonprofit debt counseling organization based in Sugar Land, Texas. “If not, the likelihood of recouping this cost is slim.”
Compare loans with APR
Looking at the annual percentage rate (APR) of your mortgage can help you compare loans with different rate and point combinations. The APR incorporates not just the interest rate, but also the points you pay and any fees the lender will charge, so it can give you more clarity and let you more easily compare apples to apples.
You can decide whether to pay points on a mortgage based on whether this strategy makes sense for your specific situation. Once you get a quote from a lender, run the numbers to see if it’s worth paying points to lower the rate for the length of your loan.
Frequently asked questions
Throughout 2022, mortgage rates rose sharply — but we’re starting to see things level off. Even so, the high rates of recent months might make mortgage points seem more attractive to many borrowers. The calculation is a little more complicated, however, than just figuring out how to get the lowest possible rate in the current market, according to Greg McBride, CFA, Bankrate chief financial analyst.“While borrowers may give greater consideration to paying points when rates have been on the rise, the breakeven point is still five+ years,” McBride says. “The benefits of paying points only truly accrue if you expect to have the loan longer than that, which might have been very plausible when rates were at all-time lows near 2.5 percent, but with rates at 6 percent or more, you’re more likely to be looking to refinance if we see a drop in rates.”Basically, points could be a good way to go if you want to set and forget your mortgage, but if you plan to manage the account more actively and refi into a lower rate if the market recedes, it might not be worthwhile to buy them now.
Whether you find a rate on a mortgage lender’s website or through a third party, the mortgage rates you see advertised might or might not include points. One rate might even seem attractively low, but that could be due to points already factored in that you might not want to pay. On Bankrate, we specify whether advertised mortgage rates include points so you can make a fair comparison between lenders.
Mortgage points on an adjustable-rate mortgage (ARM) work like points for a fixed-rate mortgage, but most ARMs adjust at five years or seven years, so it’s even more important to know the breakeven point before buying points.“Factor in the likelihood that you’ll eventually refinance that adjustable rate because you may not have the loan long enough to benefit from the lower rate you secured by paying points,” says McBride. Because the points only apply to the fixed period of an ARM, most adjustable-rate borrowers do not use them, according to U.S. Bank.
Sometimes, origination points can be negotiated. Homebuyers who put 20 percent down and have strong credit have the most negotiating power, says Boies. “A terrific credit score and excellent income will put you in the best position,” she says, noting that lenders can reduce origination points to entice the most qualified borrowers.
Mortgage discount points are tax-deductible on up to $750,000 of mortgage debt for homeowners who bought property after Dec. 5, 2017, or up to $1 million for those who purchased before that date. Generally, the points are deducted over the life of the loan, rather than all in one year. Origination points, on the other hand, are not tax-deductible, as they’re considered charges for services, like a notary’s fee or a tax preparer’s bill. Consult a tax professional if you’re not sure what homebuying expenses are tax-deductible.