Even small differences in your interest rate can have a big effect on your monthly mortgage payment and the overall cost of your loan. While the market sets overall rates, individual borrowers and first-time homebuyers can reduce the rate on their loan by buying mortgage points, also known as discount points.
When you buy mortgage points, you’re paying some of the interest on your loan upfront, allowing the lender to reduce the interest rate you’ll pay over the life of the loan. How much you can reduce your rate depends on the individual lender, how many points you buy, the type of loan you have, and overall market conditions.
Is it worth paying extra upfront for a lower interest rate? It depends. Here’s what you need to know about how points work and how they affect your loan costs.
- Points are a form of prepaid interest, and they work by reducing your mortgage rate for an upfront cost.
- One point typically costs 1% of your loan amount, and generally lowers your interest rate by 0.25 percentage points.
- The longer you own your home, the more you’ll typically save by paying for points.
What Are Mortgage Points?
Mortgage points are a percentage of the loan amount that the borrower pays upfront to get a lower interest rate. Buying points increases the homebuyer’s closing costs, but the lower interest rate will reduce both the monthly mortgage payment and the total interest paid over the life of the loan.
Every point you buy costs 1% of your loan amount. So, if you get a mortgage for $300,000, then 1 point would cost $3,000, and 3 points would cost $9,000.
You also can buy partial points, in increments usually as small as one-eighth of a percent. For example, on that $300,000 loan, you could buy 1.575 points for $4,725, or 0.5 points for $1,500.
How much your interest rate will be reduced with every point you buy varies depending on the lender, the loan type, and market conditions. Most borrowers generally can expect their interest rate to be reduced by 0.25 percentage points for each point they buy.
For example, on a $300,000 mortgage with an interest rate of 6.5%, buying 2 points would cost you $6,000 and reduce your interest rate to 6%. The lower interest rate would reduce your monthly payment from $1,896 to $1,799. Over the life of the loan, you would save $35,119 in interest for a total savings of more than $29,000.
If you buy points, how much you’ll pay for them and the reduction in your interest rate will be spelled out in your loan estimate and closing disclosure.
Lenders are required by law to discount the interest rate on loans where the borrower buys points. A loan with 1 point must have a lower interest rate than the same loan with no points from the same lender.
The inverse of points is called negative mortgage points, also known as lender credits, where you reduce your closing costs by increasing the interest rate on your loan.
Following the previous example, if you take 1 negative mortgage point on a $300,000 mortgage, then you get $3,000 in lender credits toward your closing costs. The trade-off is a higher interest rate on your loan compared to the same type of loan with no lender credits. This will increase your monthly payment and means you’ll pay more in total interest on the loan.
Benefits of Buying Mortgage Points
Here are some pros of the mortgage point system.
Get a lower interest rate
If your credit score isn’t high enough to earn you a lender’s lowest interest rate, buying points can reduce your rate and let you buy a home now instead of waiting until you have the credit score you need to buy a house that’s affordable.
Reduce your monthly payments
A lower interest rate saves you money on your monthly mortgage payment. A lower monthly mortgage payment can free up cash in your budget for other important expenses or to build your savings.
Pay less over time
Locking in a lower interest rate reduces the overall cost of your loan and saves you more money in the end than you’ll pay upfront for the points.
“A borrower that can afford to buy down the rate by paying discount points in the beginning of a mortgage term will benefit over the long run by paying a lower monthly payment,” says David Reischer, a real estate attorney and CEO at LegalAdvice.com in New York City.
May qualify for a larger mortgage
Buying points and reducing your monthly payment also would lower your debt-to-income ratio, which shows lenders how much of your income is taken up by debt obligations. Reducing your DTI ratio may show lenders during mortgage underwriting that you can afford to repay a larger loan.
For example, a 30-year fixed-rate mortgage for $500,000 at a 7.5% interest rate has a monthly payment of $3,496. If you buy points and reduce your rate to 7%, you could borrow $525,000 for $3,493 a month. With a lower interest rate, you can borrow more money for the same monthly cost.
Use our DTI ratio calculator to check your finances.
Drawbacks of Buying Mortgage Points
Here are some cons of paying points.
The upfront cost of your mortgage is higher
Buying points requires paying more for your mortgage upfront, so your closing costs are more expensive. Closing costs usually run 2% to 5% of the home’s purchase price. If you can’t comfortably afford this extra expense, then buying points might not be right for you.
It takes time for the investment to pay off
While buying points saves you money on your monthly payment and overall interest costs, it takes time for those savings to recoup the upfront expense.
Imagine you apply for a $250,000 loan and get an offer with an 8.5% interest rate. Your monthly payment on a 30-year loan would be $1,922. You decide to pay for 2 points, which costs $5,000. Doing so reduces the interest rate on your loan to 8%, making your new monthly payment $1,834. That’s a savings of $88 per month. At that rate, it will take 57 months for you to break even on the deal and start saving more in interest than you paid for points.
Moving could prevent you from recouping the cost of points
If you plan to sell or refinance your home before your savings recoup the upfront expense, buying points will cost you more money than you will save. There are also refinance closing costs — the average is about $5,000 — adding to the expense of refinancing before recouping the cost of points.
Increasing your down payment could be more beneficial
If you can afford to buy points, then it may make more sense for you to increase your down payment instead. Generally, making a larger down payment also helps reduce your interest rate, and you’ll have more home equity.
And if you’re taking out a conventional loan and your down payment is less than 20% of the home’s purchase price, then you’ll need to pay for private mortgage insurance. A larger down payment could allow you to avoid paying for PMI or stop paying for it sooner.
Should You Buy Points on a Mortgage?
So, is it worth it to pay points on a mortgage? The answer depends on your situation and goals. If you can afford the higher upfront cost, then you’ll get a lower rate, have smaller monthly payments, and pay less mortgage interest over time. But you’ll need to own your home long enough for the savings to recoup the cost of points, and you may benefit more from making a larger down payment.
“When deciding whether to pay points, three things are important: how long you plan to keep your loan, how much money you have to pay closing costs, and how much you can afford to pay each month,” says Alishea Pipkin, a retail branch manager at Legacy Home Loans in Shreveport, Louisiana.
Pros and Cons of Buying Points on a Mortgage
|Lower interest rate.
|More expensive upfront.
|Lower monthly payments.
|It takes time to recoup the cost.
|Pay less money over the life of the loan.
|You’ll lose money if you sell or refinance before recouping what you spent on points.
|May qualify for a larger loan.
|You might get more benefit from increasing your down payment instead.
Borrowers typically take four to six years to recoup the cost of buying points. So, if you’ve found your forever home, paying for points can save you thousands of dollars. But if you expect to sell your home or refinance your mortgage before then, you’ll pay more buying points than you’ll save.
What is the break-even point?
The break-even point is when your accumulated monthly savings on interest match the upfront cost of paying points. Once you pass the break-even point, you’ll begin to save money overall.
Is it better to make a larger down payment?
Depending on your goals, making a larger down payment might be a better choice. This is especially true if you don’t plan to stay in the home for long.
Say you take out a 30-year fixed-rate loan for $300,000 at a 8% interest rate, and you have $6,000 to spend on points or a larger down payment. If you put the money toward the down payment, you’d reduce your loan balance to $294,000 and have a monthly payment of $2,157. If you buy points, you’d reduce the interest rate to 7.5% on a balance of $300,000 for a monthly payment of $2,098.
Here’s how each choice would play out over different time periods:
Points vs. Larger Down Payment on a 30-Year Fixed-Rate Mortgage for $300,000
|Remaining Balance With Points
|Total Paid With Points
|Remaining Balance With Larger Down Payment
|Total Paid With Larger Down Payment
If you buy points, you’d have a lower monthly payment and pay less toward the mortgage overall. However, you’d have less home equity than if you added your extra cash to your down payment until 20 years into the loan.
The longer you stay in the home, the more beneficial paying for points becomes.
How much can you save on your monthly payment?
Let’s say you’re taking out a 30-year fixed-rate mortgage for $400,000. Here’s how buying points can affect what you pay in this example:
How Discount Points Affect a 30-Year Fixed-Rate Mortgage for $400,000
|Number of Points
|Cost of Points
|Monthly Principal and Interest Payment
|Total Savings After 30 Years
Additionally, looking at a loan’s annual percentage rate can be a useful way to compare mortgage costs. APR represents the annual cost of borrowing money and includes the interest rate, discount points, and other loan charges and fees.
How To Shop Around for Mortgage Points
Shopping for a loan with mortgage points is like shopping for any other loan. Get quotes from multiple lenders and see what they offer with regards to interest rates and fees.
Try to compare mortgage offers with equivalent down payments and points. For example, if you’re comparing offers from three lenders, make sure you get an offer that involves paying 2 points from each lender. If you get one offer with no points, one with 2 points, and one with 4 points, it’s difficult to compare them.
Mortgage Points FAQ
Here are some commonly asked questions about points.
Points may be tax deductible because they’re prepaid mortgage interest. However, you’ll need to itemize your deductions and certain conditions may apply, so check with the IRS.
While there is no legal limit on the number of points you can buy, there are federal and state laws that cap how much you can pay in closing costs. As a result, most lenders won’t let you purchase more than 4 points.
It largely depends how long you plan to stay in the home. The longer you stay in a home, the more you save by paying points. A larger down payment is good if you won’t keep the home for long because it adds to your equity. If you keep the home for the life of the loan, paying points will save you more overall.
The Bottom Line on Mortgage Points
Buying mortgage points can help borrowers reduce their interest rate and pay less each month and in overall interest on their home loan. However, homebuyers planning to move or refinance soon might not have enough time to break even and begin saving money. Points also increase closing costs, so borrowers paying points need to be prepared for the higher upfront fees. But if the borrower has cash on hand and plans to own their home for the long term, paying points can be an effective way to save money.
T.J. Porter contributed to the reporting of this article.