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. Essentially, you are prepaying interest to secure a lower rate over the life of your loan. Each point typically costs 1% of your total loan amount. For example, on a $300,000 mortgage, one point would cost $3,000.

How Mortgage Points Work

When you buy mortgage points, you pay more upfront but save money over time through lower monthly payments. The amount your rate decreases per point varies by lender and market conditions, but a common rule of thumb is that one point reduces your interest rate by about 0.25%. The actual savings depend on your loan size, term, and how long you keep the mortgage.

Calculating the Break-Even Point

To determine if buying points is worthwhile, calculate your break-even point—the time it takes for your monthly savings to equal the upfront cost of the points. For instance, if you pay $3,000 for one point and save $50 per month, it would take 60 months (five years) to break even. If you plan to stay in your home longer than that, purchasing points could save you money in the long run.

When Paying for Points Makes Sense

• Long-Term Homeownership: If you plan to stay in your home for many years, the long-term interest savings can outweigh the upfront cost.
• Stable Finances: Buyers with sufficient cash reserves may find it beneficial to invest in points rather than keeping that money idle.
• Low Market Rates: Even when rates are already low, buying points can further reduce your total interest paid over time.

When You Might Skip Mortgage Points

• Short-Term Ownership: If you expect to sell or refinance within a few years, you may not stay in the home long enough to recoup the cost.
• Limited Cash: If paying for points would deplete your savings or reduce your down payment, it may be better to keep your funds available for other expenses.
• Other Investment Opportunities: You might earn a better return by investing your money elsewhere rather than prepaying interest.

Tax Considerations

In some cases, mortgage points may be tax-deductible, particularly if they are paid on a primary residence and meet IRS requirements. However, tax laws can be complex, so it’s wise to consult a tax professional to understand how points may affect your individual situation.

Final Thoughts

Mortgage points can be a smart financial move for borrowers who plan to stay in their homes long enough to benefit from lower interest rates. However, they are not ideal for everyone. Carefully evaluate your financial goals, how long you expect to keep the mortgage, and your available cash before deciding whether to pay for points. Comparing loan offers with and without points can help you make an informed decision that aligns with your long-term financial strategy.