What Are Points on a Mortgage?

What Are Points on a Mortgage?

Buying mortgage points can save borrowers money on their loan, but it isn’t right for everyone. To determine whether or not purchasing points makes sense, borrowers must consider the upfront cost and how long it will take them to break even.

The best way to figure this out is to compare the monthly savings from reducing the interest rate with the cost of purchasing points.

What is a point?

Mortgage points are upfront fees that borrowers pay at closing in order to buy down the interest rate on their loan. They typically cost 1% of the underlying home loan amount and lower your interest rate by about 0.25 percentage points.

Each mortgage point you purchase reduces your loan’s interest rate by a fixed amount, which means that for every one point you spend, your monthly payments will drop by about $62.

Purchasing mortgage points can save you thousands of dollars on your mortgage over time. However, it’s important to understand how points work and the break-even point — when you’ll have saved enough money to cover the upfront expense of mortgage points — before making a decision to buy them.

How much do points cost?

A borrower pays mortgage points upfront in exchange for a lower interest rate over the life of the loan. Each point costs 1% of the loan amount.

Each mortgage point reduces the interest rate by a predetermined percentage, which can vary between lenders. For example, one point could reduce a 4% interest rate to 3.75 percent for the life of the loan.

Borrowers can purchase more than one point and even fractions of a point, although the law sets limits on the amount of mortgage points borrowers can pay at closing. These amounts are listed on the loan estimate and closing disclosure documents borrowers receive after they apply for a mortgage and before their closings.

Purchasing points may make sense if you choose a fixed-rate mortgage and plan to own your home for long enough to reach the break even period (the point at which the savings from the lower rate eclipses the cost of the mortgage points). Your lender can help you run the numbers to determine your exact break even point.

How do points work?

Mortgage points lower your interest rate, which saves you money on monthly payments. They’re not a profit source for lenders because the revenue from prepaid interest is offset by the expense of lowering the loan’s rate.

Each point reduces the interest rate by a certain percentage, which varies by lender. For example, one point would lower a 4% rate to 3.75 percent for the entire term of a 30-year fixed-rate conventional mortgage.

To see whether buying points is worth it, consider how long you plan to keep the mortgage and calculate your breakeven point. If you expect to sell or refinance before reaching your breakeven point, it may not make sense to purchase points.

Also, remember that mortgage points are tax-deductible, while origination fees are not. For some borrowers, the tax benefit outweighs the upfront cost of paying points. However, for most borrowers, it is better to pay down the loan principal than buy points.

Is buying points worth it?

Mortgage points are a form of prepaid interest that can lower your overall mortgage rate and monthly payments. They cost 1% of the loan amount and are due at closing. Each point reduces your interest rate by a set percentage, but this varies among lenders.

Whether buying points is worth it depends on how long you plan to live in your home and when you expect to reach the break even point, which is the point at which your upfront costs will be offset by savings from the lower interest rate. Your lender can help you calculate your break even point.

It may be worthwhile to buy points if you want to keep your mortgage for the long-term and will likely be able to deduct mortgage interest payments from your taxes. But it’s important to do the math ahead of time to make sure you won’t be moving or refinancing before you hit the break even point.