In a Nutshell
Mortgage points, also known as discount points, allow you to prepay interest on your mortgage. Sometimes this is called “buying down” your mortgage rate, because paying for points when closing on a loan reduces your mortgage rate for the life of the loan. If you’re considering buying points, you need to understand how much they cost and how much you’ll save.What are mortgage points?
When you take out a mortgage, your lender offers you an interest rate based on several factors, including market rates and your credit profile.
Lenders also offer you the opportunity to pay for a lower your mortgage rate by buying mortgage points, sometimes called “discount points.”
Points are priced as a percentage of your mortgage cost. Each point you buy reduces your interest rate by a certain amount that will vary by lender. Buying points makes financial sense when you stay in your home long enough, because you can save more on interest over time than you paid for the point.
We’ll review how mortgage points work and the pros and cons of buying mortgage points. This information can help you determine whether buying points is the right choice for your situation.
- What are mortgage points?
- How do mortgage points work?
- Should you buy mortgage points?
- Comparing mortgage loan offers
What are mortgage points?
Mortgage points, also known as discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate on your mortgage. You’re essentially prepaying some of the interest on your loan. This is also known as “buying down the rate.”
How do mortgage points work?
During closing on your mortgage loan, your lender may offer you the opportunity to reduce your interest rate by buying mortgage points. Each mortgage point costs 1% of the amount you’re borrowing.
If you borrow $100,000, a point costs $1,000. If you borrow $200,000, it will cost $2,000. You pay this fee during closing, so points increase the upfront cost of buying a home. You may even be able to buy just part of a point, such as a ½ point for $500 or ¾ of a point for $750 on a $100,000 loan.
Image: hled_mortgagepts-2Every point — or part of a point — reduces your interest rate by a specific amount that varies by lender. For example, if your lender offers a 0.25% interest rate reduction for each point you purchase on a loan with an initial interest rate of 4.25%, buying one point would bring your interest rate down to 4%.
Points are listed on your loan estimate, as well as on Page 2, Section A of your closing disclosure. Any points listed on these documents must be connected to a reduction in your mortgage interest rate.
Take note: Some lenders also refer to other fees and upfront costs as points, but the points on your loan estimate and your closing disclosure must be discount points connected to a discounted interest rate.
Discount points vs. origination points
Origination points — also called origination fees — may be charged by your lender to cover the cost of underwriting and approving the loan. Since these fees aren’t standardized, you may be able to negotiate them with your lender. And unlike mortgage points, origination points will not lower the interest rate on your mortgage.
Should you buy mortgage points?
Whether you should buy points depends mostly on how long you plan to stay in the home.
Points can cost thousands of dollars upfront, adding to the cost of getting your mortgage. But because your interest rate is reduced, the money you save on monthly payments can eventually make up for the initial cost. After you’ve covered the cost of the points you paid at closing, all additional savings from the lower interest rate is extra cash in your pocket.
Benefits of mortgage points
- Buying points can save you money in the long run — Buying mortgage points will lower your interest rate so you’ll pay less over the life of the loan. Depending on how long you live in the home, this could save you thousands of dollars.
- You may be able to lock in a lower monthly payment — By lowering your interest rate, you’ll also lower your monthly payment. This could make it easier to qualify for a home you may not be able to afford otherwise.
- You may save on your taxes — Since mortgage points are prepaid interest, you can typically deduct them from your home mortgage interest if you itemize your deductions.
Drawbacks of mortgage points
- Points are expensive, typically costing 1% of your mortgage amount — Mortgage points can quickly add up — buying 1 point on a $400,000 home would cost you $4,000. Not everyone has that kind of cash on hand.
- Buying points increases the amount you pay in closing costs — You’ll pay for mortgage points when you close on the home. So if you’re already struggling to afford the closing costs, you may want to rethink buying mortgage points.
- If you know you’ll want to move in the near future, points may not be worth the cost — If you know you’re planning to move or refinance in the next couple of years, you may just want to accept the higher interest rate.
The break-even point
To figure out if buying points makes sense for you, calculate how long it will take you to cover the upfront cost based on how much you might save.
Say you want to borrow $200,000 for a house, with the upfront cost of a point at $2,000. Divide $2,000 by the amount you save each month thanks to reducing your interest rate to see how many monthly payments it will take for you to break even.
Since the specific amount you save varies based on your lender, you’d need to calculate what your rate — and monthly payment — would be both with points and without. Let’s look at an example.
Doing the math
Let’s take the $200,000 you want to borrow for a home. If you get approved for a 30-year mortgage at 4.25%, your monthly payment to the principal and interest would be $984.
- One point: If you bought one point for a discount of 0.25 of a percentage point, you’d reduce your rate to 4%.
- Monthly savings: Your monthly payment would be lowered from $984 to $955, saving you $29 a month.
- Breaking even: Divide the point cost by your monthly savings ($2,000/$29 = 69 months). It would take you nearly six years to break even on the money you spent upfront to buy the point.
- Four points: If you bought four points to get a discount of 1 percentage point, you’d reduce your rate to 3.25%.
- Monthly savings: Your monthly payment would be lowered from $984 to $870, saving you $114 a month.
- Breaking even: Divide the point cost by your monthly savings ($8,000/$114 = 70 months). Again, it would take you almost six years to break even.
In these examples, you’d need to stay in your home for 69 months or longer to cover the cost of the points you buy and start saving money on your mortgage.
It’s hard to predict how long you’ll stay in your house. After all, life happens. But try to pin down a realistic estimate so that you’ll have a better chance of making the right decision about whether to buy points.
Comparing mortgage loan offers
Understanding how points work is just one important factor in your decision. It’s also important to know how they work when comparing loan rates. That’s because if two lenders offer you the same interest rate but one is charging a point and the other isn’t, the lender that isn’t charging the point is offering a better deal.
While you’re loan shopping, if two lenders offer you a fixed-rate loan of $200,000 at 4.25%, but one is charging a point for that rate, you’d be paying an extra $2,000 upfront with that lender to get the same rate from the other lender for free. That’s why it’s so important to comparison shop carefully and understand loan terms before you decide on a lender’s offer.
Seller concessions
Seller concessions are a percentage of the closing costs the seller has agreed to pay, and they can be mutually beneficial for the buyer and seller. Offering concessions makes the home more attractive to potential buyers, especially in a buyer’s market. For buyers, seller concessions reduce the amount of cash they need to cover their closing costs.
Next steps
Mortgage discount points allow you to reduce your interest rate by essentially prepaying interest upfront. But the savings are only worth it if you plan to stay in the home for a good amount of time.
If you’re considering buying points, think about how long you plan to stay in the home. You can also ask your lender to calculate different scenarios so you can see how much you’ll pay over the life of the loan.
FAQs on mortgage points
Each discount point costs 1% of the total loan amount. That means buying one mortgage point for a $300,000 mortgage would cost $3,000.
Buying mortgage points may be a good idea if the amount you save eventually equals or exceeds your upfront costs. But if you plan to move or refinance in a couple of years, mortgage points may not be worth it.
According to Fannie Mae’s guidelines, the number of discount points cannot exceed 3% of the total loan amount.
Discount points is another term describing mortgage points. You’ll pay an upfront fee to receive a lower interest rate on your mortgage.
Discount points are calculated based on the total loan amount. If you’re buying a $200,000 home, you’ll take that sum and multiply it by 1%. That means one discount point will cost $2,000 and two points will cost $4,000.