Mortgage Points - The Homebuyer’s Guide

What are points on a mortgage and what do they mean for you as a homebuyer? This is a question that many people have when getting ready to buy a home. Mortgage points, also known as buying down the rate, are fees that you pay to your mortgage lender in order to get a lower interest rate on your mortgage. 

Mortgage points are essentially prepaid interest that give the buyer a lower interest rate on their home loan. The amount of points that buyers pay can vary based on their credit score, the type of loan they choose and other factors. Points can be thought of as an upfront investment that allows the borrower to save money in the long run.

Below, we’ve compiled a quick guide on what homebuyers need to know about mortgage points.

What are mortgage points?

Mortgage points are fees paid to lower the interest rate on a mortgage loan. Each point costs 1% of the total loan amount. For example, on a $500,000 loan, one point would cost $5,000. 

Mortgage points are also referred to as discount points or buy-down points. Some lenders offer loans with no points, while others may require the borrower to pay 2 to 3 points to achieve a specific mortgage rate. Paying points can lower the monthly mortgage payment and save you money over the life of the loan. 

However, it's important to calculate whether the upfront cost of points is worth the long-term savings. Borrowers should also compare rates from multiple lenders to get the best deal. A good rule of thumb, for a 30-year fixed-rate mortgage, each discount point you pay will get you a 0.125% to 0.25% rate reduction on your mortgage.

If you choose to buy down your rate, the amount you will pay to do so will be itemized along with all other closing costs in the loan estimate provided by your lender.

Mortgage Points Example - $600,000 Loan

• Purchase price: $900,000
• Down payment: $300,000
• Loan amount: $600,000
• Mortgage points: 2 points
• Points cost at closing: $12,000
• Mortgage payment (30-year, 5%): $3,220.93
• Rate reduction: 0.50% (0.25% per point)
• Mortgage payment (30-year, 4.5%): $3,040.11
• Monthly savings: $180.82
• Break-even point: 66.36 months ($12,000 / $180.82)
• Interest savings over 30 years: $65,094.44

How do you calculate how many points to pay on a mortgage loan?

The amount of points you pay on a mortgage loan is determined by several factors, including the interest rate, the loan amount, and the length of the loan. 

To calculate the points you'll need to pay, you'll first need to compare the interest rates of different loans.The interest rate is the percentage of the loan that you'll need to pay back in addition to the principal. The higher the interest rate, the more points you'll need to pay. 

You'll also need to consider the loan amount when calculating points. The larger the loan, the more points you'll need to pay. 

Finally, you'll need to consider the length of the loan. The longer the loan, the more points you'll need to pay. By considering all of these factors, you can calculate how many points you'll need to pay on your mortgage loan.

When is the best time to pay mortgage points?

If you’re planning on staying in your home for a long time, it may make sense to pay points up front and enjoy the lower monthly payments. On the other hand, if you think there’s a chance you may sell your home in the near future, it may be better to skip paying points as the upfront cost will be greater than the total savings. 

When mortgage rates are low, many buyers forego the cost of points. However, when mortgage rates are high or rapidly increasing, homebuyers are more likely to consider the option as a trick to achieve a lower mortgage rate. 

Are there any tax benefits associated with paying mortgage points?

Mortgage points can generally be deducted as interest on your federal taxes, providing you meet certain criteria. In order to take the deduction, you must itemize your deductions on Schedule A of your tax return, and the points must have been paid in order to acquire the mortgage. Additionally, the mortgage must be used to purchase or improve your primary residence. 

If you meet all of these criteria, you can deduct the full amount of mortgage points paid in the year they were paid. For example, if you paid $6,000 in points on a $600,000 loan in 2020, you could deduct the entire amount on your 2020 tax return. Paying mortgage points can provide valuable tax savings if you understand how the deduction works and if you meet all of the eligibility requirements.

What are the risks associated with paying mortgage points?

While paying points may save you money over the life of your loan, there are also some risks to consider. 

First, you will have to pay the points even if you sell the property or refinance the loan within a few years, so they are a sunk cost. Second, if interest rates fall after you close on your loan, you may be stuck with a higher rate than if you had not paid points. 

As with any financial decision, it is important to weigh the risks and rewards of paying mortgage points before making a commitment.

How can a homebuyer get the most value with mortgage points?

Buying points can be a good way to save money on interest over the life of the loan, but it’s important to calculate whether it makes financial sense in each individual case. 

Homebuyers should compare the interest rate with and without points to see how long it would take to recoup the cost of the points. They should also consider their plans for the property – if they anticipate selling it in the near future, they may not stay in the home long enough to benefit from the lower interest rate. 

Ultimately, whether or not to buy mortgage points is a decision that should be made based on each homebuyer’s unique circumstances.

Thinking about buying a house with a mortgage this year? Estimate your potential monthly payment with Prevu's mortgage calculator.