What Are Mortgage Points and How Do They Work?

Buying a new home is one of the biggest purchases many people will ever make. With mortgage rates still hovering above 6%, buying a home has become much more expensive than it was just a few years ago. This has led many buyers to explore options for making homeownership more affordable.

Buying mortgage points, also referred to as discount points, is one option borrowers can use to lower their interest rate. Whether it makes financial sense depends on the upfront cost, the rate reduction offered, and how long the borrower expects to keep the loan. Keep reading as we walk through what mortgage points are, how they work, and some of the pros and cons of purchasing them.

Key Findings

• Mortgage points are fees you pay your lender at closing to get a lower interest rate. Each point costs 1% of your loan, so one point on a $400,000 loan is $4,000. How much your rate drops depends on the lender and the market. Points are not the same as origination fees, which cover the lender’s paperwork and don’t change your rate.
• A lower rate means a smaller monthly payment and less interest paid over time. Points can sometimes be tax-deductible, but you’d want to check with a tax professional. The tradeoff is that you need more cash at closing, which leaves less for things like moving or repairs.
• Points only make sense if you stay in the home long enough to earn back what you paid. To find out when that happens, divide the cost of the points by how much you save each month. If you sell or refinance before that point, you lose money, so it’s smart to compare offers from a few lenders first.

What Are Mortgage or Discount Points?

Mortgage points are fees you pay your lender at closing in exchange for a lower interest rate. You're essentially paying some of your interest upfront to lower your monthly mortgage payments and reduce the overall interest cost over the life of the loan.

How Do Mortgage Points Affect Interest Rates?

Each mortgage point you buy costs 1% of your loan amount. So, if you're borrowing $400,000, one point would be $4,000. In exchange for this fee, you may receive a lower interest rate. The amount of the rate reduction varies by lender, loan scenario, and market conditions.

While most people buy full points, some lenders also allow you to purchase partial points. For example, you could buy a half point on your $400,000 mortgage for $2,000.

You can also choose to buy multiple points to lower your interest rate further. However, before proceeding, it's a good idea to do the math to make sure points will actually help you save money over the life of your loan.

No matter how many points you decide to buy, the fee will be added to your closing costs. You should see discount points disclosed among your closing costs on your loan documents.

Discount points are typically paid at closing rather than rolled into the loan balance, although the exact structure of closing costs can vary by loan scenario.

Can Mortgage Points Be Used With an FHA Loan?

If you're planning to use an FHA loan to buy a home, you might wonder whether you can use mortgage points. FHA borrowers may be able to use discount points to reduce their interest rate, but FHA loans have specific rules about fees and closing costs.

FHA limits certain lender origination charges, while discount points are typically considered separately. Even so, any charges must comply with FHA and lender requirements and should be reasonable for the transaction.

If a seller pays discount points on an FHA loan, that contribution may affect how seller-paid closing costs are treated under FHA rules. Buyers should review this with their lender.

Discount Points vs. Origination Points

Some buyers confuse discount points with origination points. These are two different things. Unlike discount points, origination points do not affect your interest rate. Origination charges are lender fees associated with processing and underwriting the loan and do not directly buy down the interest rate.

Origination charges may be structured in different ways depending on the lender. Not all lenders require borrowers to pay origination charges, and lender fee structures can vary significantly. Borrowers should review their Loan Estimate carefully to understand what they are being charged and why.

Pros and Cons of Buying Mortgage Points

Before deciding whether to buy mortgage points, it's important to consider the pros and cons.

Pros

• Lower interest rate: Paying discount points may reduce your interest rate, though the amount of reduction varies by lender and market conditions.
• Lower monthly payment: Securing a lower interest rate means your monthly mortgage payment will also decrease.
• Long-term savings on interest: A lower interest rate could help you save significantly on financing charges over the life of your loan.
• Potential tax benefit: In some cases, the cost of mortgage points may be tax-deductible. See the FAQ below for important details.

Cons

• Higher upfront closing costs: Buying mortgage points will increase the cash you need at closing.
• Break-even takes time: It only makes sense to buy mortgage points if you plan to stay in the home long enough for the monthly savings to exceed the upfront cost.
• Refinancing risk: If rates drop and you refinance before reaching your break-even point, the money spent on points may not pay off.
• Less cash for other expenses: Paying for points upfront means less cash available for things like renovations or moving costs.

Frequently Asked Questions

What is one mortgage point worth?

One mortgage point costs 1% of your loan amount. The interest rate reduction it provides varies by lender, loan type, and market conditions. Discount point pricing and eligibility can vary. Therefore, borrowers should compare loan estimates from multiple lenders to determine if buying points is beneficial for their situation.

Are mortgage points tax deductible?

Mortgage points may be tax-deductible in some cases, depending on IRS rules and your individual tax situation. Common factors that affect eligibility include:

• The loan is secured by your primary residence
• Buying points is an established practice in your area
• The points were paid at closing
• The points are calculated as a percentage of the loan amount
• The points are included on the closing disclosure

Because tax treatment depends on your specific circumstances, borrowers should consult a qualified tax professional for guidance.

How long does it take to break even on mortgage points?

The break-even point is when your cumulative monthly savings equal the upfront cost of buying points. You can estimate it by dividing the cost of the points by your monthly payment savings. A lender can help you compare the upfront cost of points with the projected monthly savings to determine whether purchasing points aligns with your plans for the loan.