What are points on a mortgage?
Mortgage points are a form of advance interest you pay upfront in exchange for a lower interest rate.
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Writer, Fox Money
Daria Uhlig is an expert on mortgages and real estate with bylines at USA Today, GoBankingRates and MSN Money.
Updated September 23, 2024, 3:31 PM EDT
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Over 58% of borrowers with home purchase loans and 56.2% of borrowers with non-cash-out refinance loans used mortgage points last year, according to the Consumer Financial Protection Bureau. Mortgage points allow you to lower the cost of financing your purchase by paying more money upfront.
Points on a mortgage are prepaid interest that reduces the rate you pay on your mortgage loan. The lower rate means a lower monthly mortgage payment, but you’ll have to bring more cash at closing to get it.
What are mortgage points?
A mortgage point, also called a discount point, is an advance interest payment that equals 1% of your mortgage loan amount. In exchange for this upfront payment, which is due at closing, the lender discounts your mortgage loan rate. The discount varies by lender and might be anywhere from 0.25 percentage points to 4 percentage points, according to Freddie Mac.
Mortgage interest rates have been hovering just below 7% since May, but many analysts predict rates to sink at least a half of a percentage point by the end of the year. While down from a recent record of 7.79% last October, the rate is still high enough to make some consumers think twice about buying a home. If you want to buy a home, but don’t want to wait for rates to come down, buying mortgage points might help you secure a lower interest rate — and lower monthly payments.
How do mortgage points work?
Say you want to buy a $425,000 home with $85,000 down and a $340,000 mortgage loan. If the lender offers you a 7% mortgage rate, your payment will be $2,262 per month. Over the life of a 30-year home loan, you’d repay a total of $814,330, of which $474,330 would be interest.
Now say the lender offers you the opportunity to reduce your rate by purchasing two mortgage discount points. Two points would equal 2% of your mortgage amount, or $6,800 using the example above. That’s the amount of interest you’ll pay in advance, at closing. In return, the lender will reduce your interest rate to 6.50%.
With this arrangement, you’ll have to pay the $6,800 in addition to other closing costs, but now your interest rate is only 6.50%. That reduces your monthly mortgage payment to $2,149, which is $113 less than the payment with no points. The total interest payment over the life of the loan drops by $40,649, to $433,651.
When should you buy mortgage points?
Determining whether to buy mortgage points comes down to figuring out whether you’ll live in your home long enough to benefit — and if so, whether points are the best use of your cash.
Buying mortgage points might make sense if you have enough cash to pay them at closing and you’ll stay in your new home long enough for that upfront investment to pay off.
Using the previous example, it would take about five years to break even. That means the points purchase would only save money if you remained in your home for five years and 11 months.
Even if you’re likely to break even, it’s a good idea to compare the mortgage interest savings to the savings you’d receive if you used the $6,800 for a larger down payment instead. Rather than borrow $340,000, you’d only need $333,200. Your payment for that loan amount would be $2,106 ($43 per month less than the payment with points), and you’d save $8,673 in interest over the life of the loan.
Keep in mind:
Consider other ways you might use the money besides paying for your home – for example, emergency savings, investing, renovations, and repairs. Try to balance all of your financial goals when you decide whether to pay more money upfront.
The S&P 500 has a 7.93% annualized growth rate over the long term, according to YCharts. Investing $6,800 in an S&P 500 index mutual fund could leave you with a $67,000 nest egg in 30 years.
Of course, there are no guarantees with the stock market like there are with a 30-year fixed-rate mortgage loan so you would be assuming some amount of risk with that investment.
Seller-paid points
If you’ve not yet made an offer on a home but plan to use points to reduce your mortgage rate, you have another option: seller concessions.
Rather than purchasing points on your own, you can ask for them as a seller concession when you submit an offer on a home. Requesting such a concession can weaken your offer, but some sellers might prefer paying the concession over reducing their asking price.
Benefits of buying mortgage points
Points can benefit buyers in several ways:
- Lower mortgage interest rate
- Lower monthly mortgage payment
- Mortgage interest tax deduction
- Potentially easier loan approval
Drawbacks of buying mortgage points
Points also have some drawbacks that offset — and can even wipe out — the benefits:
- Require more cash for closing
- Can take years to recoup the upfront payment
- Ties up money that could be used for other purposes
How to calculate the break-even point for mortgage points
The break-even point occurs when your points-based savings — the amount you save on your monthly mortgage payments and the interest you pay — equals the amount you paid for the points.
You can calculate the break-even point by dividing the cost of points by the amount you save on your monthly payments.
An easier way is to use an online break-even calculator. Just enter the loan information the calculator asks for to determine the number of years and months before you break even.
For example:
Using the earlier example, in which you spent $6,800 upfront and will pay $43 less per month, you’d divide $6,800 by the $43 savings. That comes out to 159 (rounded) months. Divide 159 by 12 to find out when you’ll break even — just over 13 years.
What are points on a mortgage FAQ
How much is 1 mortgage point worth?
One point costs 1% of the loan amount. If you were to take out a $100,000 mortgage, a discount point would cost $1,000. Keep in mind that the discount on your interest rate varies by lender, and could be between 0.25 percentage points and 4 percentage points.
Are mortgage points the same as a buydown?
Yes. A buydown is when a buyer or homeowner purchases points to lower a mortgage rate. While some buydowns are permanent, others are temporary, lasting just a few years.
How do mortgage points affect monthly payments?
Mortgage points reduce your mortgage payments by lowering your interest rate. A lower rate means less of your money goes toward interest, so your payment is smaller.
Are mortgage points tax-deductible?
Yes. Most homebuyers can deduct mortgage points in the same year they pay them as long as they’re charged as a percentage of the total loan amount, itemized as points on the closing statement, and meet other requirements from the IRS.
How many mortgage points can you buy?
The number of points you can buy varies by lender. Most mortgage lenders limit points to four or fewer.
Can mortgage points reduce closing costs?
No. Mortgage points are a form of interest you pay in advance, at closing. Therefore, they increase your closing costs. However, requesting that a home’s seller pay the points on your behalf, as a concession, reduces the amount of cash you need to close.
How do lender credits relate to mortgage points?
Lender credits are the opposite of points in a sense. You pay points upfront in exchange for a lower interest rate and you accept lender credits upfront in exchange for a higher interest rate.
How many points are normal for a mortgage?
Although you might be able to buy up to four points, most buyers purchase a median of one point, which means half buy more than 1 percentage point and half buy less.
Is it a good idea to buy mortgage points?
It can be, for the right buyer. Mortgage points could work well for a buyer with savings to cover the down payment, closing costs, and points who plans to spend a number of years in their home. Buyers with less or no spare cash for closing, and those who plan to move within the first couple of years after they buy, might lose money on points.