How Mortgage Points Work and When to Pay for Them

Mortgage points are fees that you pay your mortgage lender upfront to reduce your loan’s interest rate and, in turn, your monthly payments. A single mortgage point equals 1% of your mortgage amount. Therefore, if you take out a $200,000 mortgage, a point is equal to $2,000. You may pay more now, but you’ll reduce your long-term costs. However, this may not be a good move for everyone.

To decide whether mortgage points make sense for you, speak with a financial advisor.

What Are Mortgage Points?

Mortgage points are additional payments made at closing for a lower interest rate and lower monthly payments. That’s why buying points is often referred to as “buying down the rate.”

It can lower what you pay your mortgage lender in the long run. Even better, it can get you closer to owning your own home outright sooner.

In the home buying world, there are two types of mortgage points.

1. Discount Points

With discount points, the more points you buy, the more your rate falls.

Lenders set their own mortgage point framework. Therefore, rate limitations ultimately depend on your lender’s terms, the type of loan and the overall housing market. However, you can typically expect to lower yours by 0.25%. Discount points are tax-deductible for the first $750,000 of your mortgage loan.¹

Weigh how long you plan to stay in your house and how much cash you have at closing. The longer you stay in your house, the more money you end up saving by buying discount points. Likewise, the more money you have available at closing, the better chance you have of paying for discount points.

2. Origination Points

Origination points cover the loan processing fees that your lender incurs.

The amount of interest you can shave off with discount points can vary. However, you can typically negotiate the terms with your lender. These are part of the overall closing costs, and some lenders include them based on your credit or borrowing profile.

Origination points are not tax-deductible, but thankfully, many lenders have stopped requiring them. Instead, lenders are offering flat-fee or no-fee mortgage options, especially for strong borrowers.

How to Calculate Mortgage Points

Let’s say you take out a 30-year fixed-rate mortgage for $200,000 with an interest rate of 5.5%. Your monthly payment without points would be $1,136.

Then, let’s say you buy two mortgage points for 1% of the loan amount each, or $4,000. As a result, your interest rate dips to 5%. You end up saving $62 a month because your new monthly payment drops to $1,074.

To determine when you’ll start saving, divide the amount you paid for your points by your monthly savings ($4,000/$62). The result is 64.5 months, or about 5.3 years. That means if you stay in your home longer than this, you’ll save money in the long run.

Keep in mind that our example covers only the principal and interest on your loan. It doesn’t account for additional factors like property taxes or homeowners insurance.

A free mortgage point calculator can help you run the numbers.

When Mortgage Points May Not Make Sense

Buying mortgage points can reduce your interest rate, but paying them upfront does not always lower your overall borrowing costs. Before deciding to purchase points, compare the upfront expense with how long you expect to keep the loan.

For example, assume paying $4,000 for mortgage points lowers your monthly payment by $60. It would take roughly 67 months to recover that upfront cost through monthly savings. If you expect to move or refinance before then, you may spend more on points than you save in interest.

Your cash position also matters. Money used to purchase mortgage points cannot be used for a larger down payment, closing costs, moving expenses or an emergency fund. Buyers with limited savings after closing may benefit more from preserving cash than from reducing their monthly payment.

Future interest rates can also influence the decision. If mortgage rates fall after you purchase points, refinancing into a lower-rate loan could shorten your original mortgage. In this situation, you may not hold the loan long enough to recoup the cost of the points before refinancing.

When Are Mortgage Points Worth It?

When you take out a mortgage, you can often buy mortgage points.

If you’re buying a home and have extra cash for your down payment, you could consider buying down the rate. This would lower your payments going forward.

This is a good strategy if the seller is willing to pay some of the closing costs. Often, the process counts points under seller-paid costs, and if you pay them yourself, mortgage points are usually tax-deductible.

In many refinance cases, closing costs are rolled into the new loan. If you have enough home equity to absorb higher costs, you can pay mortgage points. You can then finance them into the loan, lowering your monthly payment without paying out of pocket.

Additionally, if you plan to keep your home for a while, it would be smart to pay points. Paying $2,000 may seem like a steep charge to lower your rate and payment by a small amount. However, if you save $20 on your monthly payment, you’ll recoup the cost in a little more than eight years.

Remember, the lower the rate now, the less likely you are to refinance in the future. Even if you pay no points, you’ll incur costs every time you refinance. In a low-rate environment, paying points to get the absolute best rate makes sense. You’ll likely never want to refinance that loan again.

However, when rates are higher, it would actually be beneficial not to buy down the rate. If rates drop in the future, you may refinance before fully realizing the value of the points you paid for.

Should You Pay for Points on a Mortgage?

If you can’t afford to make sizable upfront payments at closing, you may keep the current interest rate and refinance your mortgage later.

Refinancing a mortgage uses a new loan to pay off your first mortgage, while providing a better interest rate on the new one. This makes sense if you’ve made timely payments on your old mortgage, paid off a decent amount of your principal and improved your credit score since the initial mortgage.

If you have some money in your reserves and can afford it, buying mortgage points may be a worthwhile investment. This is most beneficial when you can afford them and intend to stay in your home for a long time.

If this is the case for you, first crunch the numbers to see if mortgage points are truly worth it. A financial advisor can help you through this process if you aren’t sure where to start.

What Are Origination Fees?

Why do so many lenders quote an origination fee?

To get a true no point loan, lenders must disclose a 1% fee and then give a corresponding 1% rebate. Wouldn’t it make more sense to quote a loan at par and let the borrower buy down the rate?

Lenders do it this way because of the disclosure laws in the Dodd-Frank Act.² If the lender does not disclose a fee upfront, it cannot add it later. Say a lender discloses a loan estimate before locking in the loan terms. In this case, the lender is bound by those terms if it fails to disclose an origination fee (or points).

If rates rise during the loan process, you may be forced to accept a higher rate. Suppose you applied for a loan when the rate was 3.5%. However, when you’re ready to lock in, the rate is worse. Your loan officer says you can get 3.625% or 3.5% with the cost of a quarter of a point (0.25%).

If no points or origination charges show up on your loan estimate, the lender cannot offer you this second option. You would be forced to take the higher rate.

Bottom Line

As with most financial decisions, whether or not mortgage points are necessary for you will depend on your personal situation.

As with most financial decisions, your personal situation will determine whether or not mortgage points are necessary for you. It’s a good idea to run some simulations using a mortgage calculator. This will give you an idea of how the purchase of points will affect your long-term mortgage payments. Be sure that your mortgage payments fit within your budget so you can enjoy your new home without financial strain.

Consider working with a financial advisor who can help you prepare for the homebuying process, including the necessary closing costs.

Tips for Buying a Home

Buying a home is no small feat, so it can be helpful to work with a financial advisor to figure out your finances beforehand. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Before you fall in love with your dream home, figure out what prices are actually within your budget. To help you out, check out SmartAsset’s how much home can I afford calculator. All you need to know is where you’re looking for homes, your marital status, your annual income, your current debt and your credit score.
SmartAsset’s no-cost closing cost calculator will help you understand your total closing costs and amount needed at settlement.