What are mortgage points ⁠— and how do they work?

As mortgage rates continue to sit at historically low-interest rates, potential buyers have the chance to save thousands of dollars on their home purchase. You can take advantage of the low rates to refinance your mortgage as well to reduce your monthly payments. Using mortgage points could allow consumers to obtain even lower prices.

If you anticipate staying in your home for several years and don’t plan to refinance your mortgage for a while, purchasing points could be a cost-saving option. Mortgage points may not be the best option for every buyer, so it’s essential to do a little research to find out the best solution before you start the mortgage process.

What are mortgage points?

Two types of mortgage points apply to new purchases and home refinances.

• Origination points apply to all loans and include fees for administering and processing the loans. Some mortgage lenders charge a flat rate, some charge a percentage of the loan total.
• Discount points refer to fees that mortgage lenders charge to allow borrowers to reduce the interest rate on their loan. Sometimes discount points are referred to as prepaid interest.

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How do mortgage points work?

Mortgage points allow borrowers to reduce the interest rate on the life of their loan by either paying for the points upfront or rolling the additional cost into the loan total. The reduced rate is good for the entire life of your investment.

Borrowers can typically purchase one to three percent of the total principal. Each point is worth one percent of the entire loan. For example, one point on a $400,000 mortgage would equal $4,000. Each point you purchase lowers the interest rate by about .25 percent.

The Federal Trade Commission recommends asking your lender to quote a dollar amount versus a point quote, so you know how much you’ll have to pay before committing. Credible can introduce you to view different types of mortgage loans and compare multiple lenders' offers at once. Find out what kind of mortgage refinance rates you qualify for today.

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Should I buy mortgage points?

Maybe. If you can afford to pay for the points upfront and intend to keep the home for several years, then you should buy mortgage points. Ideally, you want to at least break after buying points.

As an example, let’s consider a $400,000 loan financed for 30 years at a 5 percent interest rate. If you don’t purchase points, your monthly payment would be about $2,147 per month. If you bought 2 points, it would cost you around $8,000 and lower your interest rate to 4.5 percent. You would pay $2,026 per month (a savings of $120.55 per month). You would need to own the home for at least 49 months to break even, and you could potentially save more than $43,000 in interest over the life of your loan.

In this example, you’d want to own the home for at least four years to break even. To begin saving money, you should be in the home longer.

This calculation assumes you can pay for the points upfront and don’t roll them into your loan cost. If you financed these same points, you would need to live in the property for 119 months (almost 10 years) to break even. You can use a mortgage calculator specifically for points to help you decide if purchasing points is the right decision for you.

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Are mortgage points tax-deductible?

In 2017, the federal government passed a new tax law that made origination and discount points tax-deductible. Discount points are tax-deductible up to the first $750,000 of a home. To deduct the points on your tax form, you’ll need to itemize them on your Schedule A form.

Before you opt to deduct the points on your taxes, check to see if you qualify for a higher standard deduction that would save you more money versus itemizing your discount points. This helpful sheet from the IRS will help you determine if deducting your points is beneficial for your situation.

If you’re in the position to purchase a home or refinance your mortgage, now could be a great time to take advantage of lower rates and potentially score even lower rates by utilizing mortgage points. Keep in mind that you’ll want to build in a little extra time to navigate the lending system as lenders are handling an influx of cases due to the historically low-interest rates.

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If you're still not sure if buying points is right for you, consider speaking with a financial advisor for guidance.