Lower your interest rate and save money in the long run by paying for points up front.
Updated January 22, 2020|7 min read
Table of Contents
Buying mortgage points, also called discount points, can lower your mortgage rate
One mortgage point can typically lower your interest rate by 0.125% or 0.25%, but it depends on your lender
Mortgage points are a trade-off: you pay higher upfront costs, but you pay less overall in the long run
You may be able to deduct the cost of mortgage points on your tax return
When most people purchase a home, they’ll have to take out a mortgage, a loan specifically for buying the house. If the interest rate a lender offers you is too high, you can actually lower it by using mortgage points. Also known as “buying down the rate”, borrowers purchase these discount points to lower their mortgage interest rate by a small percent or fraction of a percent.
Mortgage rates are tied to economic factors, but they also rely largely on your credit score. Lower interest rates mean a lower monthly mortgage payment and potentially more savings. A mortgage point may be worth an eighth or a quarter of a percent and the cost is based on your loan amount. For example, you might pay $3,000 on a mortgage point to reduce your interest rate by 0.25% (from 5.00% to 4.75%) for a $300,000 30-year fixed-rate loan. You would save around $45 a month and over $15,000 over 30 years.
For some people, the upfront cost may be worth it, particularly if you have the extra cash on hand and plan to stay in your home for a long time. The savings from mortgage points don’t happen until you break even, which in this example would be about five and half years into the life of the loan. If you don’t plan on staying in the house this long, the cost of buying these points may not be worth it, and the money might be better spent, like towards a higher down payment.
We’ll discuss how mortgage points work, look at an example, and see when it’s worth it to buy them.
If you’re looking for another type of mortgage point, called origination points you can learn about them here. Origination points (or origination fees) are charged by the mortgage lender to help them make money.
Also called a discount point, a mortgage point is a way to pay your lender a set amount up front (as part of your closing costs) in exchange for a lower interest rate on your loan. Using mortgage points can also be called “buying down” your rate.
Lenders benefit from points, too, since it is a way for them to receive cash in hand faster and buying points would make you less likely to sell the home, refinance your mortgage, or even default before breaking even on the points.
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The points are factored into your closing cost, and can reduce your APR, or annual percentage rate, which is your mortgage interest rate plus other costs associated with your mortgage, like any fees. (The APR is the rate at which you can expect your payments to be calculated from.) Points for adjustable-rate mortgages are applied to the fixed-rate period of the loan.
How much a mortgage point is worth varies by the lender. There isn’t a set amount for one point, but usually one mortgage point equals an eighth or a quarter of a percent (0.125% to 0.25%) . For example, if you have a 5% interest rate, buying one point might lower the interest rate to 4.75% or 4.875%, depending on your lender’s terms. If you’re buying mortgage points, you can buy more than one, or even a fraction of one, if the lender allows it. While the government sets a limit to how much in origination fees a lender can charge, there isn’t an overall limit on how much in closing costs a borrower might pay.
If you’re interested in mortgage points and lowering your interest rate, ask your lender for a rate sheet to see the interest rates and corresponding mortgage points. Better yet, you should ask the lender for the specific dollar amount you’d have to pay to lower your mortgage rate by a specific percentage, since points (and fractions of points) can be confusing.
The cost of a mortgage point is usually equal to 1% of your loan amount . That means mortgage points get more expensive the bigger your mortgage is. For example, if you have a $100,000 loan, one point will cost $1,000. but if you have a $500,000 loan then a mortgage point would cost $5,000.
The way mortgage points work is that the borrower essentially prepays a chunk of interest ahead of time by making a larger upfront payment (which is however much your mortgage points cost). Over time, you can save a lot of money that you pay on your mortgage, but it’ll take a while for your savings to start. More on that later.
The best way to understand how points work is through an example. Let’s say you’re taking out a 30-year fixed-rate mortgage for $300,000 and you’re offered a 5.00% interest rate. According to the rate sheet from your lender, lowering the interest rate by 0.25% would cost one point. See the following table.
|No points||1 point|
|Cost of points||NA||$3,000|
|Total interest costs after 30 years||$279,671||$263,373|
|Total interest savings after 30 years||NA||$16,343|
We got the numbers using our mortgage calculator, which shows your monthly payments. Check it out to see how much house you can afford.
Whether or not it is smart to buy mortgage points is based on your individual circumstances. The first thing to decide about buying mortgage points is whether you have enough cash on hand for this to even be an option.
If you do have the cash, then it’s time to do some math in order to decide whether buying discount points and lowering your monthly mortgage bill through a lower rate is the best use of that money.
Financial calculators, like a mortgage points calculator, can tell you how long it will take you to break even — or start saving — if you buy mortgage points. We’ll show you how to calculate it on your own.
As the example shows, buying one point on a $300,000 loan can save you thousands of dollars in interest payments in the long run. But those savings don’t start right away — because of the upfront cost of $3,000.
Borrowers will want to know when the actual savings kick in that make the cost of buying mortgage points worthwhile. The break-even point is how many months after it’ll take for that to happen.
The break-even point = cost of mortgage points/monthly savings
To calculate the break-even point using our example: the cost of mortgage points ($3,000) divided by the monthly savings ($45) = 67 months.
That means buying points won’t save you money until after five years and seven months (67 months) into the lifetime of the mortgage. For reference, a 30-year mortgage lasts 360 months.
The longer that you keep your home and your mortgage, the more you’ll save in the long run, which means buying points may not be worth it if you plan to sell your house before you break even.
Learn more about how mortgage interest works.
Did you know interest on your mortgage loan is actually tax-deductible, up to $750,000? Since points are essentially prepaid interest, they may be deductible, too. You should speak with a tax advisor to find out if your points qualify and get more information about how much you can save.
Learn more about claiming the mortgage interest tax deduction.
If the mortgage lender offers you a higher interest rate, remember that you can always shop around for a new loan servicer. (Remember to check today's mortgage rates here.) The rate that the mortgage lender offers you is largely based on credit score. If you’re not in great financial standing, taking some time to increase your credit score might benefit you a lot.
Keep in mind that when you buy mortgage points you are only lowering the interest rates, but not decreasing the principal loan amount. However, making a larger down payment can help cut down your overall loan amount, which is key because you’ll pay much less over time with a smaller mortgage principal.
Additionally, if you can pay 20% down payment or more, then you don’t have to pay private mortgage insurance (PMI), another added cost. Work with your lender or financial advisor to do the math and see what’s the right choice for you.
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