Mortgage Points

What are mortgage points?

Buying a home comes with many new terms. One term that often confuses first-time buyers is "mortgage points." Simply put, mortgage points are a way to pay more upfront to save money over time.

Also known as "discount points," these are fees you pay directly to your lender at closing in exchange for a reduced interest rate. Think of it as prepaying some of your interest to lower your monthly payments for the life of the loan.

How do mortgage points work?

The math behind mortgage points is relatively standard across the industry. One point typically costs 1% of your total loan amount.

For example, if you are borrowing $400,000, one point would cost you $4,000 at closing.

In exchange for that upfront fee, the lender lowers your interest rate. While it varies by lender and market conditions, one point usually lowers your rate by 0.25%.

So, if you were quoted a rate of 6.5%, buying one point could drop that rate to 6.25%. You can also buy fractions of a point (like 0.5 points) or multiple points, depending on how much cash you have available at closing.

When should you buy mortgage points?

Deciding whether to buy mortgage points comes down to one major factor: time.

Buying points is a long-term strategy. Because you are writing a larger check at closing, you need to stay in the home (and keep the same mortgage) long enough for the monthly savings to add up and exceed that upfront cost. This is called your "break-even point."

You should consider buying points if:

• You plan to keep the home for a long time (5+ years).
• You have extra cash reserves after your down payment and closing costs.
• You want the lowest possible monthly payment.

You might skip points if:

• You plan to move or refinance within a few years.
• You are tight on cash for closing.
• Interest rates are expected to drop significantly in the near future (since you might refinance anyway).

How to calculate your break-even point

To figure out if mortgage points are worth it for you, you can do a simple calculation.

1. Calculate the Cost: Determine how much the points will cost you upfront. (e.g., $4,000).
2. Calculate the Savings: Find out how much money the lower rate saves you per month. (e.g., $30 per month).
3. Divide: Divide the upfront cost by the monthly savings.

Example:

$4,000 cost ÷ $30 monthly savings = 133 months

In this scenario, it would take you roughly 11 years (133 months) to break even. If you sold the house after 5 years, you would actually lose money on the deal. However, if the savings were $100 a month, the break-even would be just 40 months (3.3 years), making it a much smarter investment.

Are mortgage points tax deductible?

Yes, in many cases, mortgage discount points are tax-deductible. Because they are considered prepaid interest, the IRS often allows you to deduct them in the year you paid them, provided you meet certain requirements (like using the loan to buy your primary home). Always consult with a tax professional to check whether or not your eligible.