Mortgage Points: What Are They & Should You Pay Them?

Your mortgage rate drastically affects what you pay in interest over the life of your home loan, so the lower that rate is, the better. When you take out a new mortgage, there are ways to qualify for a lower interest rate — for instance, improving your credit score or lowering your debt-to-income ratio.

Another option to help you lower the rate is buying mortgage points.

While getting a lower rate might sound great on the surface, the process can be confusing and isn’t always the best option for every situation. We’ll explain what you need to know about mortgage points and whether buying them is right for you.

What Are Mortgage Points?

Your lender may offer the chance to buy mortgage points (also known as discount points) when you take out a mortgage on a house or refinance your existing home loan. Essentially, buying mortgage points means paying interest upfront to the lender. By doing so, you can lock in a lower rate for the life of the loan.

Generally, each point costs 1% of the total mortgage amount and knocks 0.25% off the interest rate.

For example, if you take out a $200,000 mortgage and purchase one point for $2,000, you could lower a 4.25% interest rate to 4.00%. Your monthly mortgage payment would decrease from $983 to $954, a savings of $29 per month. Since you paid $2,000, which led to a savings of $29/month, it would take almost 69 months (five years and nine months) to break even. Over the length of a 30-year mortgage, you would save over $10,000 in interest.

The more points you buy, the more you save. It’s up to the lender to decide how many points a borrower can purchase, which may depend on the type of loan you secure and the current mortgage market conditions. Any points you pay for are listed on your Loan Estimate and itemized on the Closing Disclosure. You officially pay the points when you close on your new home.

Deciding Whether to Buy Points

Now that we’ve explained how mortgage points work let’s look at some scenarios to help you determine if they are worth buying.

Length of time in the home: Paying for mortgage points makes the most sense if you plan to live in your home for a long time. Crunch the numbers to determine when the lower mortgage payment will surpass the initial expense of buying points. If you are confident that you won’t sell or refinance before reaching the break-even point, it may justify buying points.

If you think there is a chance you may need to sell or refinance before you’d break even, consider parking the money in a reliable investment account (like a high-yield Certificate) instead of paying for points.

Down payment amount: Do some calculations to determine whether paying for mortgage points or making a higher down payment makes more financial sense.

If you put less than 20% down, you could be required to pay private mortgage insurance (PMI). PMI typically costs between 0.5% and 1% of the total loan amount per year, potentially negating the benefit of buying points.

Your PMI will phase out after building up 20% equity in the house, eliminating your PMI payments and potentially lowering your interest rate. (This applies only to conventional loans. If you obtain an FHA loan, the only way to drop PMI is to refinance.)

Remember, you can pay mortgage points when you refinance, so if you make a smaller down payment, waiting until then to purchase points could be advantageous. Ask your lender which loan type you are being offered so they can help you understand whether it’s a good fit.

Type of home loan: Mortgage points make the most sense when paired with a fixed-rate loan. With an adjustable-rate mortgage (ARM), your interest rate, and therefore your payment amount, changes over time. Buying points might save you money on a loan that adjusts at seven or 10 years, but probably not at five years.

Tax deductibility: Points are deductible as mortgage interest on primary residences, second homes, and rented houses. Just keep these conditions in mind:

• The loan must be secured against your home, whether you’re purchasing, building, or renovating.
• You must buy points by paying the lender directly.
• If you purchase points when refinancing a mortgage, the deduction may need to be spread over the entire loan term.

Contact a tax professional if you have any questions.

Paying mortgage points could be a great way to reduce housing costs when you buy a new home or refinance your mortgage, but do some calculations to help you decide if it’s worthwhile. If you need help, our Mortgage team can assist you.