What are mortgage points and how do they work?

Mortgage points, also known as discount points, are a fee you pay your lender upfront to get a lower interest rate on your loan. A lower interest rate can reduce your monthly payment — and reduces the total amount of interest you’ll pay over the life of your mortgage. This practice is often referred to as “buying down the interest rate” or a “buydown.”

How do mortgage points work?

Each mortgage point typically lowers your loan’s interest rate by 0.25 percentage points for the life of the loan. In exchange for this lower rate, you’ll usually pay your lender 1% of the mortgage amount.

Your lender may value points differently. If you’re thinking about buying points, ask your loan officer for specifics.

You can buy more than one point, and even fractions of a point. A half-point on a $400,000 mortgage would typically cost $2,000 and lower the mortgage rate by about 0.125%.

You’ll pay for the points at closing. They’re called “prepaid interest” on the loan estimate, which you’ll receive within three business days of applying for a mortgage, and the closing disclosure, which you’ll receive at least three business days before closing the loan.

When you receive your mortgage loan offer, first clarify whether the stated quote requires you to pay points. If you can’t get that rate without paying points, you might want to ask for another quote that doesn’t require them. You can then compare the differences in rates.

Permanent vs. temporary rate buydowns

When you buy discount points on a mortgage, usually you’re locking in a lower rate permanently. But in some cases, a lender might offer a temporary buydown, which is usually paid for by the lender. One of the most common temporary buydowns is a 3-2-1: a rate that’s 3% lower for the first year of the loan, 2% lower for the second year of the loan and 1% lower for the third year of the loan. After that, you pay the full interest rate for the remainder of the loan term.

A temporary buydown tends to make the most sense if you expect your income to increase. Because the reduced payments phase out, it can also help ease the transition if you’re stretching to afford a new home now but believe you’ll be able to manage the full payment comfortably within a few years.

On the other hand, skipping points altogether — whether permanent or temporary — may be a better move if your closing costs are already tight or if you’ll likely move or refinance before a buydown period ends (temporary) or before you hit your break-even point (permanent). In such cases, it can be more useful to devote that same cash toward a larger down payment or your emergency fund rather than to a rate reduction you might not ultimately benefit from.

How much can you save by paying mortgage points?

If you can afford to buy discount points on top of your down payment and closing costs, you’ll lower your monthly mortgage payments and could save money overall. The key is staying in the home long enough to recoup the prepaid interest. If, after only a few years, you sell the home, refinance the mortgage or pay it off, buying discount points could mean you lose money.

Here’s an example of how discount points can reduce costs on a $400,000 mortgage with a 30-year term:

In this example, by buying two points for $8,000 upfront, you lowered your monthly payment by $133 and saved $47,858 in interest over the life of the loan. However, to save that full amount, you would have to live in the home for the full, 30-year loan term and never refinance.

How to calculate your break-even point

To calculate the point at which you’d recover your outlay on the prepaid interest, divide the cost of the mortgage points by the amount the reduced rate saves you each month.

From the previous example: $8,000 / $133 = 60 months.

In this case, you would have to stay in the home for about 60 months, or five years, to recover the cost of the points. You can use Bankrate’s mortgage points calculator and amortization calculator to figure out whether buying mortgage points will save you money.

Should you buy down your interest rate with points?

Whether buying mortgage points makes sense depends on your break-even point — and with today’s home prices, that can stretch to five or more years. The longer it takes to recoup the cost of your points, the more carefully you should think about buying them — especially if there’s a chance you’ll refinance before you break even on the points.

For some, buying points might not be worth the time or the relatively small amount of monthly savings.

“I’m ambivalent about paying points. It strikes me as a lot of extra analysis without a big reward,” says Jeff Ostrowski, writer and housing market analyst for Bankrate. “But, if it’s very important to you to lower the rate over the life of your loan, and you have cash on hand to make it work, go ahead. Just make sure you’ll keep the mortgage long enough to recoup the upfront costs.”

When is it a good idea to buy mortgage points?

Buying mortgage points is more likely to make sense in specific situations. For example:

• If you plan to be in the home for a long time: Because buying mortgage points reduces the rate for the life of the loan, every dollar you spend on points goes further the longer you pay that mortgage. If you plan to be in the house for years to come, the amount you’ll save is likely to make the upfront cost worth it.
• If you don’t plan to refinance any time soon: Generally, it’s not worth paying for points if you plan to refinance to a different rate before the break-even point.
• If you have other pressing financial priorities: Buying points makes more sense if you already have an emergency fund in place and aren’t carrying high-interest debt. Otherwise, that money will likely go further when devoted to those purposes.

If you’re not sure whether you should buy down your rate with points, do the math. It might make more financial sense to use the money you’d spend on points to make a bigger down payment, which would reduce the amount you need to borrow.

Frequently asked questions

• How are mortgage points factored into APRs?

  The annual percentage rate, or APR, you see on a lender’s website or through a third party might or might not include points. If a rate seems surprisingly low, it’s likely because points — which you may not want to buy — are already factored in. Be sure to read the fine print.

• Are mortgage points tax-deductible?

  If you  itemize your tax deductions, you can deduct mortgage points as part of the mortgage interest deduction. Mortgage interest and mortgage points are tax-deductible on up to $750,000 (or $375,000 if married filing separately) of mortgage debt for homeowners who bought property after Dec. 15, 2017, or up to $1 million (or $500,000 if married filing separately) for those who purchased before that date. Origination points are not tax-deductible.

• How do mortgage points work with adjustable-rate mortgages (ARMs)?

  With an ARM, buying mortgage points only lowers the rate on the initial fixed-rate period of the loan, usually three, five, seven or 10 years. Because of this, it’s not very common to buy points on an ARM.

• Can you negotiate mortgage points?

  Origination points won’t lower your interest rate like discount points. An origination point is a standard fee your lender charges to create, process and underwrite your loan, and it typically equals 1% of your total mortgage. Like discount points, origination points are included in your closing costs. Not all lenders charge origination points, as some offer loans with no or reduced closing costs, but this often translates to a higher interest rate or other fees instead.

• What is the difference between discount points and origination points?

  In some cases, you can negotiate mortgage points. Lenders have some flexibility in how they price points, and getting quotes from multiple lenders can give you leverage to get a lender to improve its pricing overall, whether it’s the quoted rate or a point cost.