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

What Are Mortgage Points?

Mortgage points, sometimes called discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate on your loan. Essentially, you are prepaying some of the interest to secure a lower rate over the life of the mortgage.

Typically, one point equals 1% of your total loan amount. For example, if you take out a $300,000 mortgage, one point would cost $3,000. The exact amount your interest rate decreases per point varies by lender and market conditions, but it often ranges from 0.25% to 0.50% per point.

Types of Mortgage Points

• Discount Points: These are the points that reduce your interest rate. They are optional and can be used strategically to lower your monthly payments or total interest costs.
• Origination Points: These are fees charged by the lender for processing your loan. They do not reduce your interest rate and are essentially part of the lender’s administrative costs.

How Mortgage Points Affect Your Loan

Paying for points increases your upfront costs but can save you money over time. The key factor is how long you plan to stay in the home or keep the mortgage. If you remain in the home long enough to recoup the cost of the points through lower monthly payments, buying points can be a smart move.

For example, if you pay $3,000 for one point and it reduces your monthly payment by $50, it would take 60 months—or five years—to break even. If you plan to stay in the home longer than that, you’ll start saving money after the fifth year.

When Paying Points Makes Sense

• Long-Term Homeownership: If you plan to stay in your home for many years, paying points can lead to significant interest savings over time.
• Stable Financial Position: If you have enough cash on hand to cover both your down payment and the cost of points without depleting your emergency savings, it may be worthwhile.
• Low Interest Rate Environment: Even when rates are already low, buying points can help you secure an even better rate, which can be beneficial for long-term savings.

When You Might Skip Paying Points

• Short-Term Ownership: If you plan to sell or refinance within a few years, you may not stay in the home long enough to recoup the cost of the points.
• Limited Upfront Funds: If paying points would strain your finances or reduce your down payment, it may be better to keep your cash for other expenses.
• Other Investment Opportunities: If you can earn a higher return by investing your money elsewhere, paying for points may not be the best use of your funds.

Calculating the Break-Even Point

To determine whether paying points is worthwhile, calculate your break-even point—the time it takes for your monthly savings to equal the cost of the points. Divide the total cost of the points by your monthly savings to find the number of months needed to break even. If you expect to keep the mortgage longer than that, paying points could be beneficial.

Tax Considerations

In some cases, mortgage points may be tax-deductible, especially if they are discount points paid on a primary residence. However, tax laws can be complex, and eligibility depends on your specific situation. It’s best to consult a tax professional to understand how points may affect your deductions.

Final Thoughts

Mortgage points can be a useful tool for lowering your interest rate and saving money over the life of your loan, but they are not right for everyone. Carefully consider your financial goals, how long you plan to stay in the home, and your available cash before deciding. By weighing the upfront cost against potential long-term savings, you can make a more informed decision about whether paying mortgage points is the right move for you.