Mortgage Points vs. Down Payment: What's the Difference?

Mortgage points vs. bigger down payment key factors

A point is prepaid interest; so buying points is paying part of your mortgage interest upfront instead of over the life of the loan. However, a larger down payment reduces the principal balance of the loan, resulting in less interest accruing over time.

How long you will be in the house plays a big factor in whether you should buy points or put down a large down payment. Calculate the break-even point for buying points versus a large down payment, and determine how long you need to keep the mortgage to make buying points make sense.

You’ll also want to look at your own personal cash situation. Avoid putting down all your cash, making sure you keep enough aside for closing costs, moving costs, repairs or furniture for your new home.

“If you plan to stay in the home long enough, that upfront cost can absolutely be worth it,” said Sean Wilkoff, an assistant professor of finance at the University of Nevada, Reno. “However, if there is a good chance you will refinance or move in a short enough amount of time, you may be better off keeping your cash.”

You also want to avoid paying private mortgage insurance (PMI), if possible. If buying points means you have to put less than 20% down, be sure to calculate the cost of PMI into your equations. That will make buying points much less favorable.

Here are the key factors you can consider when deciding to put your cash toward mortgage points versus a bigger down payment, based on a $400,000 home price.

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Mortgage points vs. down payment monthly savings

Typically, buying a point costs 1% of the total mortgage and will reduce the interest rate by 0.25%. So if you had a $400,000 home and $80,000 to put down, your mortgage would be $320,000, one point would cost $3,200, and would reduce your interest rate by 0.25%.

Let’s look at three scenarios:

• 20% down with no points or any extra down
• 20% and buying two points
• 20% down, plus an additional $6,400

The break-even point of buying two points on a $400,000 in this scenario is four years. If you plan to keep the mortgage for more than four years, you are better off using the extra funds to buy down your mortgage rate. However, if you are planning to keep the house for less than four years, you would save more money by using the extra funds as a larger down payment.

Keep in mind, in all scenarios, the buyer is putting 20% down. If buying points means putting less than 20% down, you’ll also have to include PMI in the calculations.

PMI will cost between $30 and $70 per $100,000 owed. So the more you put down, the less PMI you will pay, and you won’t have this cost at all if you put at least 20% down.

When to choose mortgage points or bigger down payment

Use a calculator to find the break-even point for your situation. If you are planning to keep the new mortgage for longer than the break-even point, then you may want to buy the points. This will save you the most money over the long term. You may also choose to itemize that year for additional tax savings.

However, if you plan to move or refinance in a few years, then you’ll most likely want to avoid buying points and put more money down instead.

You’ll also want to consider your own cash flow situation. If buying points or putting a larger down payment will cause you to be low on cash, it may be best to keep the cash on hand for upcoming expenses. Moving into a new home can be more expensive than you might expect.

Mortgage points tax deduction

Mortgage points that are used to buy down the interest rate are considered mortgage interest and are tax-deductible in specific situations. These are:

• The loan must be for your primary residence.
• The points were a percentage of the mortgage amount.
• The number of points purchased was a common business practice in your area.
• You did not use loan proceeds to pay for the point.
• The points were considered prepaid interest.
• The points are listed on your closing documents.
• You itemize your deductions.

You can also deduct points paid by the seller on your behalf.

While being able to deduct your points is helpful, it’s unlikely to change the break-even point on your mortgage by much. Also, if you regularly itemize, you can deduct the mortgage interest you pay each year, which will be slightly higher if you don’t buy points. So the interest will be deducted one way or the other.

Being able to deduct the points will make the largest impact if you are able to itemize in the year you buy the points, and then take the standard deduction for the other years.

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Tax deduction when refinancing

If you’re refinancing your loan, the points are not typically deductible in the year that you pay them. Instead, the deduction is taken evenly over the term of the loan. If you pay off the loan early, either by making additional payments, refinancing with another company or selling the property, you can take the unclaimed deduction in the year the loan is paid off.

However, if you refinance with the same company, you must continue the same deduction schedule.

If you take cash out from the refinance and use it to make upgrades to your home, you can take the deduction for points paid for that portion of the loan in the year you pay the points. For example, if you refinance for $200,000 but take $100,000 to upgrade the house, you’d be able to deduct half of the points paid on your next tax return.