If you’re shopping for a home loan, you may be wondering if using mortgage points to “buy down” your interest rate is a good move for you.
The answer is … it’s complicated.
Whether you’re buying or refinancing your home, purchasing mortgage points from your lender can lower your monthly payment and reduce the overall amount of interest you’ll pay on your loan. And that’s certainly an appealing prospect.
But it’s important to understand how points work — how much they can cost and how much they might save you over the life of your loan — before you decide to hand over that extra cash up front at your closing.
What Are Mortgage Points?
Mortgage points, also known as discount points, may be used by a borrower to prepay some of the interest on a home loan in exchange for a lower mortgage rate. The borrower pays more up front (the points are paid as a fee at closing) but can end up saving money over time because the interest rate is then reduced for the life of the loan.
How Do Mortgage Points Work?
Lenders typically base their interest rate offers on several factors, including a borrower’s credit profile and current market rates. But once you receive that initial offer, your lender also may give you the opportunity to buy down your rate through the use of mortgage points. (If the lender doesn’t bring it up, you can ask.)
Every point purchased reduces the interest rate a borrower pays by a predetermined percentage, which can vary from one lender to the next. But let’s say your lender offers you an initial rate of 3.25% and provides a 0.25% rate reduction if you purchase one discount point. If you decide to buy the point, your rate would then be 3%.
Each point you buy typically costs 1% of the amount you’re borrowing, and that money is due up front. So, for example, if your loan is for $200,000, a point will cost $2,000 at closing. If that seems too steep, you may be able to purchase a fraction of a point. A half-point in this scenario would cost $1,000, or three-quarters of a point would be $1,500.
How Do Points Affect Your Mortgage?
Here’s a hypothetical example to illustrate how buying one point could reduce the cost of a 30-year, fixed-rate $200,000 mortgage. (This is a bare-bones example, so the payment amount includes principal and interest only.)
|Discount points purchased||None||1 point ($2,000)|
|Total interest paid||$113,348||$103,555|
|Total saved over life of the loan||None||$9,793|
Keep in mind that the borrower in this scenario would have to stay with the loan for the entire 30-year term to get the full savings — and that can be rare these days. The average home tenure in early 2021 was eight years, according to ATTOM Data Solutions.
That’s why it’s important to factor in your “break-even point” — when the savings from the lower mortgage cost offset what you paid for the discount points — before you make your decision.
What Is the Break-Even Point?
Paying points on a mortgage can lower your monthly payment and save you thousands of dollars — if you keep the same loan long enough to recover the money you paid up front. If you plan to move or refinance before you reach and pass that threshold, paying points may not make sense.
To calculate the approximate point at which you would get back what you spent on prepaid interest, you can divide the amount you paid for any points by the amount you’ll save each month on your payment.
For example, if you purchased one point for $2,000 at closing, and you’ll save $27 each month on your payment by going from a 3.25% interest rate to 3%, you can expect to break even in 74 months — or about six years. If you plan to stay in your home much longer than that, buying down your rate could be worth considering.
Can You Buy Points for an ARM?
You can buy points if you decide to go with an adjustable-rate mortgage (ARM) instead of a fixed-rate mortgage.
But it may not be worth it if the points apply only to the ARM’s initial interest rate, which typically lasts for three, five, seven, or maybe ten years. If the rate goes up after that and you decide to refinance, you could lose out on the savings you hoped to get when you paid for the points.
Recommended: How an Interest Only Mortgage Works
Are Mortgage Points Tax Deductible?
Discount points, which are considered prepaid interest, may be deducted as home mortgage interest if you itemize deductions on Schedule A of your Form 1040. But the amount you’ll be able to deduct may be limited.
If your home acquisition debt (the amount of the mortgage you took out to buy your home) exceeds the limit for your filing status, you may not be able to deduct all of the mortgage interest and points. And unless you meet several IRS requirements, you might not be allowed to deduct the points in full in the year you paid them. Instead, points that don’t meet the IRS requirements may be deducted proportionately each year over the life of the loan.
It’s important to note that only discount points, which represent prepaid interest, are tax deductible. “Origination points,” which also may be referred to as mortgage points, are not tax deductible. These points, which you’ll also pay at closing, refer to the various fees lenders may charge in preparing your mortgage (such as processing, underwriting, administration, or document preparation costs).
Your accountant or tax preparer should be able to answer your questions if you aren’t clear about the amount you can deduct on your annual return.
Is There a Limit on the Points You Can Buy?
The maximum number of points you can purchase to reduce your interest rate may differ based on factors like the financial institution, type of loan you choose, or how much you need to borrow.
According to a survey of lenders performed weekly by Freddie Mac, the average number of points reported on 30-year, fixed-rate conventional loans in 2021 was 0.7.
Benefits and Risks of Mortgage Points
Here are some things to consider when you’re deciding if buying points makes financial sense for you.
How Long Do You Plan to Stay in the Home?
If you run the numbers and think you’ll keep your loan past your break-even point, it could be worth paying extra up front. But if it’s a starter home, or you expect to relocate for your career, buying points may not be prudent.
Do You Have Plenty of Money Saved?
Homeownership can be expensive. Are you certain you have enough saved to make a decent down payment, pay for points as well as other closing costs, and still have funds in reserve for the inevitable expenses related to homeownership? If not, you may want to reconsider the benefits of buying down your interest rate.
Did the Seller Agree to Pay Some Closing Costs?
If the seller agreed to pay some or all of your closing costs, you may be able to negotiate discount points as part of that offer. And you still may be able to deduct the cost of the points on your tax return.
Do You Plan to Make Extra Payments?
Paying for points could be a smart strategy if you expect to hold on to the same loan for a long time. However, if your goal is to pay off your mortgage early — perhaps by paying more toward the loan principal whenever possible — points may not offer the savings you expected.
Would the Money Be Better Spent on Your Down Payment?
If you have plenty of money saved and you’re trying to decide between increasing your down payment or buying points, you may want to run the numbers to determine which choice will give you a better return on your investment.
If your time horizon is short, you may save more by making a bigger down payment. If you plan to stick around for several years at least, you may choose to put your money toward discount points.
Remember, depending on the type of loan you have, if you make a down payment that’s less than 20%, your lender probably will require that you purchase private mortgage insurance. PMI could add about 0.3% to 1.5% to the cost of your mortgage. And you’ll likely have to pay it every year until your equity in the home reaches 20%.
Pros and Cons of Mortgage Points
|You can lower your monthly mortgage payment||High up-front costs can make closing even more expensive|
|You may be able to save on interest over the life of your loan||Could deplete cash needed for furniture, renovations, moving, etc.|
|Discount points may be tax deductible for those who itemize||Could lose money if you sell or refinance before breaking even|
Ready to Go Rate Shopping?
Make sure when you shop rates, you’re comparing apples to apples. Some lenders may offer an interest rate that appears lower than others but has a fraction of a point or a point tied to it. If two lenders are offering a 3% interest rate on a 30-year, fixed-rate loan, but one is charging a point to get that rate and one isn’t, the one that isn’t charging the point is offering you a more affordable deal.
Be cautious when comparing mortgage rates: If it isn’t clear how much you’ll pay to borrow, you can ask a loan officer to walk you through your loan estimate and/or to calculate your costs based on different time frames.
Lenders are required to disclose information about their products in a way that allows borrowers to make meaningful comparisons.
What’s the point of mortgage points? They allow homebuyers to reduce their loan’s interest rate by paying some of the interest up front. Buying discount points can save you money on interest over time, but only if you keep the loan long enough to recover the upfront cost.
You can use a mortgage calculator to see how buying points might affect your interest rate, monthly payment, and overall savings.
And if you have more mortgage questions, you can get plenty of useful homebuying information at SoFi’s help center for home loans.
Photo credit: iStock/Prostock-Studio
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