Mortgage lenders offer multiple pricing options for home loans. You can choose to pay more points upfront in exchange for a lower interest rate and payment, or you can pay less upfront and accept a higher interest rate.
In general, the more you pay upfront, the lower your interest rate and payment. When choosing a loan, you’ll need to weigh the tradeoffs between upfront cost vs. benefits over time
What Are Mortgage Points?
Put simply, a mortgage “point” is one percent of your loan amount. That’s it. You might be charged points to process, underwrite and fund your loan. These points are usually called an origination fee.
You might choose to pay additional “discount points” points to get a lower interest rate and payment. Paying mortgage discount points is often called “buying down the rate” and could offer savings over the course of the loan, says Bryan Sherman, wealth management lending executive at Bank of America.
Mortgage points don’t have to be nice, round numbers. Your origination fee might be .5 points, 1.2 points or some other fraction. Discount points can also be fractional.
Imagine that you’re taking out a $400,000, 30-year fixed-rate loan with a 6.75% interest rate. The following table outlines what you can expect to pay with and without mortgage discount points.
| Total mortgage points | None | 1 | 2 | 3 |
| Cost for mortgage points | N/A | $4,000 | $8,000 | $12,000 |
| Interest rate | 6.75% | 6.50% | 6.25% | 6.00% |
| Monthly payment | $2,594.39 | $2,528.27 | $2,462.87 | $2,398.20 |
| Total interest | $533,981.26 | $510,177.95 | $486,632.77 | $463,352.76 |
| Break-even point | N/A | 60 months | 61 months | 61 months |
As the table illustrates, mortgage points increase your upfront costs but reduce the amount of interest you’ll pay over the life of the loan – assuming that you keep the loan for its entire term. In this example, buying three points would cost you an additional $12,000 at closing, but could save you over $70,000 in interest charges.
Understand that you’ll lose money paid for discount points if you sell your home, refinance your mortgage or pay off your loan before reaching the break-even point.
“Consult a lending specialist to run the numbers to help determine how the points will affect your loan,” Sherman says. “Under certain circumstances, buying mortgage points when you purchase a home can save you significant money over the course of your loan. But it’s important to understand how they work and how long it takes for the additional upfront cost to be worthwhile.”
Note that with real-world loan pricing, every point doesn’t necessarily reduce your interest rate by .25%. The rate reduction you get from discount points varies among lenders and programs. And even with the same lender and program, the additional reduction from a second or third point isn’t necessarily equal to the reduction from paying one point.
[READ: Compare Current Mortgage Rates]
APR and Mortgage Points
Here is pricing from the rate sheet of a national mortgage broker (July 10, 2024) for a 30-year fixed-rate mortgage:
— 6.500% 2.846 points APR: 6.780%
— 6.625% 1.474 points APR: 6.769%
— 6.750% 1.107 points APR: 6.859%
— 6.875% 0.752 points APR: 6.949%
— 7.000% 0.411 points APR: 7.041%
In this example, it only costs .759 points (1.10 minus .411) to drop your rate by .25% from 7% to 6.75%. But you’d have to pay an additional 1.739 points (2.846 minus 1.474) to drop your rate another .25% from 6.75% to 6.5%.
So, which price point is the best deal? Assuming that you keep the loan for its entire term, you can find that “sweet spot” combination of cost and rate by comparing the loan’s annual percentage rate, or APR. APR incorporates both loan fees and interest and makes it easier to compare mortgages with different pricing. If you keep your loan for 30 years, paying 1.474 points for a 6.625% rate gets you the lowest APR.
Mortgage Discount Points vs. Origination Points
In mortgage lending, the word “points” can mean different things, and it may be confusing. But it doesn’t need to affect how you compare mortgages or choose a home loan.
Mortgage lenders can charge individually for services like loan processing, document preparation, courier fees, and underwriting, but most roll them into a single origination fee. Origination fees typically range between 0.5% and 1% of the total loan amount. Because the origination fee is expressed as a percentage, loan professionals often refer to it as “points.”
Mortgage discount points, on the other hand, are not fees. When you pay discount points, you’re prepaying part of your mortgage interest upfront, and the lender gives you a lower rate in exchange.
But wait; there’s more. You could always go the opposite direction, accept a higher interest rate, and the lender will pay discount points to you. You can use these “negative discount points” to cover your origination fee and other costs like property taxes or title insurance.
Deducting Mortgage Points on Your Taxes
The IRS allows you to deduct discount points for the year that you pay them as long as they meet the following criteria:
— The points relate to a mortgage to buy, build, or improve your primary residence.
— Your primary residence secures the mortgage.
— Paying points is an established business practice in your area.
— The points paid weren’t more than the amount generally charged in that area.
— You or the seller must actually pay the points. The lender can’;t pay them or add them to your loan.
— The points were computed as a percentage of your loan amount.
— The amount shows clearly as points on your settlement statement.
You’ll know how much you get to write off when your lender sends you a Form 1098 (Mortgage Interest Statement). Points paid that don’t meet the above-listed criteria, like points to refinance a home loan or to buy a second home, can’t be written off in one year but may be deducted over the life of the loan.
Getting a Seller to Pay Your Points
Suppose that you’re negotiating the purchase of a $400,000 home. You plan to put down 20% and finance the rest. And you expect to negotiate a discount on the price. In this example using real-life pricing, you’re better off negotiating 3% in discount points than a 3% sales price reduction.
| Asking price | Sales price | Loan amt | Rate | Pmt | Total paid |
| $400,000 | $400,000 | $320,000 | 6.500% | $2,023 | $728,142 |
| $400,000 | $388,000 | $310,400 | 7.125% | $2,091 | $752,840 |
In this case, you’d pay less by making a full-price offer with 3 discount points paid by the seller. It’s smart to run these numbers every time you make an offer on a home.
Pros and Cons of Buying Mortgage Points
Should you pay mortgage points? Discount points come with some advantages for borrowers, but there are trade-offs to consider. “For many, paying for discount points on top of the other costs of buying a home is a financial stretch,” says Joe Mileo, senior project manager at mortgage lender Better.com.
Pros
— You may pay less interest over the life of your loan. As long as you keep your loan beyond the break-even point.
— Buying down your interest rate can help you qualify for a loan if your debt-to-income ratio is high. By lowering your monthly payment, you may be able to get your DTI low enough to meet your lender’s guidelines.
— You may be able to get a seller to pay your points. Buying down your rate could impact your payment more than negotiating a lower purchase price.
Cons
— The upfront cost can be very high. Between the down payment and closing costs, financing a home can be hard on your wallet. Adding the cost of discount points might hurt your financial security.
— May not be cost-effective. You might have better uses for the money – like paying down debt, boosting retirement savings or making an investment. And you don’t come out ahead until you’ve kept your mortgage beyond its break-even point. That may not be possible.
“In general, buying mortgage points is most beneficial when you intend to stay in your home for a long period of time and can afford the upfront costs of mortgage points,” Mileo says.
More from U.S. News
A Guide to Seller-Paid Mortgage Rate Buydowns
Is a No Closing Cost Mortgage Right for You?
To Buy or Not to Buy: The Real Deal on Mortgage Points originally appeared on usnews.com
