What are Mortgage Points, and How Do They Work?

Home Buying

Apr 28

For most of us, a home represents the biggest purchase we’ll ever make. It’s therefore prudent to familiarize ourselves with the myriad—and often unnecessarily confusing—terms we’re likely to encounter during the mortgage process. In this post, we’ll cover “discount points” (also known as “mortgage points”) and arm you with the tools you need to evaluate whether or not this is a worthwhile purchase.

What are mortgage points?

These discount points are a one-time fee paid directly to the lender in exchange for a reduced mortgage interest rate: an exercise also known as “buying down the rate” or a “buydown.”

A single “point” generally lowers your interest rate anywhere from one-eighth (0.125) to one-fourth (0.25) percent and costs one percent of your total mortgage. Thus, if you borrow $500,000, one mortgage point will cost $5,000.

Mortgage points vs. origination points

Note that discount points differ from “origination points,” which are required fees—generally paid at closing—mortgage lenders charge to underwrite and process your loan. Origination fees vary by lender and often cost anywhere from half a percent to one percent of your mortgage. While these increase your costs, they don’t affect the interest rate on your mortgage.

How do mortgage points work?

While the degree to which points lower rates inevitably varies by lender, a single point generally reduces interest rates by an eighth (0.125) to a quarter (0.25) percent: costing one percent of your total mortgage amount. You can also buy more than one point—or even a fraction of a point—so if you borrow $500,000 and purchase two points (for example), this will cost you $10,000.

Though points are typically paid for at the mortgage closing, some lenders roll discount points (as well as other closing costs) into the loan amount—especially with respect to mortgage refinancing. This option reduces and sometimes even eliminates the need to shell out additional cash upon closing on a new home.

Are mortgage points worth it?

The longer you reside in your home, the more it makes sense to pay for points (typically). You should therefore only consider doing so if you’re confident you’ll remain there for an extended period of time. This is, of course, assuming you can afford to pay for points in the first place: meaning you’re certain the cash outlay (or higher monthly payment, if fees are rolled into your mortgage) won’t adversely impact your lifestyle.

How to calculate the break-even point for mortgage points

To determine if purchasing discount points is worthwhile, you need to calculate your "break-even point" (meaning when your accumulated monthly savings equal upfront fees paid for points). Doing so is easy! Simply take the total cost of the points and divide that number by your monthly mortgage payment savings, giving you the number of months you'll need to stay in your home to break even.

To illustrate, let's assume you have a 30-year $300,000 mortgage with a 6% interest rate and the lender gives you the option to purchase up to two points for $6,000: reducing your interest rate to 5.75%.

First, compare your mortgage payments in each scenario. Your monthly payment would ring in at $1,799 with a 6% rate, while 5.75% drops this to $1,751—saving you approximately $48 a month.

Next, divide the $6,000 price tag by your monthly savings ($48) to get 125: your break-even point indicating you'd need to remain in your home for 125 months (10.5 years) to recoup the money spent buying down your mortgage rate.

While the math here is straightforward, predicting how long you'll indeed live in your new home is much more complex. Keeping in mind the median homeownership duration in the U.S. is just over 12 years, it may be beneficial to buy down your mortgage rate per the provided example (assuming the additional cash expenditure won't affect your desired lifestyle).

How discount points benefit lenders and borrowers

Mortgage lenders benefit from discount points by receiving cash upfront rather than waiting—making their loans more profitable—with cash payments also enhancing their liquidity, especially important as financial institutions are required to hold a significant amount of liquid assets.

Mortgage borrowers, meanwhile, benefit by paying a lower monthly sum as point payments reduce their interest rate.

Other discount point considerations

Advertised mortgage rates may already include points
When shopping for mortgages, know some lenders may include points in advertised rates that in turn seem lower than they actually are. To make it easier to compare different lenders, request mortgage rates that don't include any points or optional upfront fees.

Points are sometimes tax deductible
As points are considered prepaid interest, the IRS generally allows you to deduct the full amount of your points in the year you buy them—provided you itemize deductions on your tax returns.

Points are sometimes offered in reverse
Another aspect of points is that lenders may also offer them “in reverse”: meaning you actually receive points from your lender in exchange for paying a higher interest rate. This option—also known as a “rebate”—most often appeals to borrowers who are perhaps low on cash or applying for low or no-money-down mortgages.

The bottom line on home loan discount points

It’s important to zero in on two primary considerations when evaluating discount points. The first is affordability, ensuring the cash you use to pay for points won't adversely impact your lifestyle. The second is how long you plan on living in your home. If you’re confident you’ll stay put for a long time (well beyond the break-even point), then paying for points to reduce your mortgage rate is often a worthwhile investment.

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FAQs

In this case, many lenders often dictate the discount is only applicable during the initial fixed-rate period and will no longer apply thereafter—often concerning as this loss can occur before you even reach the break-even period. Consequently, it quickly becomes evident that buying mortgage points on an ARM loan may ultimately favor the bank rather than the borrower and is thus not beneficial in the long run.
While our firm works with various financial institutions, your best bet is to shop around: comparing the details of at least three lender offers to ensure you’re getting a good deal and ideally throwing a credit union into the mix as many are very competitive in the mortgage space.
Government-sponsored organization Freddie Mac reported more than half of U.S. borrowers—especially those who refinanced their mortgages—paid discount points in 2023 as mortgage rates hovered around 7%, noting this suggests that "discount points may not be worth it from a consumer's perspective." While it's understandable to seek steps to counteract high interest rates, calculations related to points remain unchanged. Furthermore, paying mortgage points is likely not a smart investment for those planning to refinance in the near future.