What are mortgage points?

When you’re buying a home, it’s important to get the best interest rates possible. Homebuyers have the option to purchase mortgage points at the time of closing. A mortgage point is a fee paid directly to the lender in exchange for a lower interest rate. As a result, your closing costs will be higher, but you will have a lower monthly mortgage payment. Over time, this may save you money on your home loan.

In this article, we’ll explore the basic mechanics of how mortgage points work and help you to determine whether paying points is a smart financial investment.

How do mortgage points work?

A mortgage point, sometimes called a discount point, is a one-time purchase made at the time of closing. Each mortgage point corresponds to a particular reduction in interest. Your lender sets the exact number, but most lenders will offer a reduction of 0.25% of your interest rate for every point. Some companies refer to paying points as “paying down the interest” — essentially, you're buying your rates down with points.

A mortgage point typically equals 1% of your total mortgage amount. For example, on a $200,000 loan, each mortgage discount point is $2,000. When you pay this fee, the lender agrees to reduce the interest rate on your loan.

The number of points you can pay varies according to your lender. Some lenders have a maximum number of points you can use, while others let buyers pay points in increments as small as one-eighth of a point.

How much are mortgage points?

To lower the cost of your monthly mortgage payments, you can pay points when your loan is issued.

Each point is typically 1% of your total home loan, so one point on a $100,000 loan is $1,000. You can also pay for fractions of points.

Points are purchased during closing, so they will increase your overall closing cost. Be sure to factor this into your budget when you’re purchasing a home.

Because points are purchased upfront, there are no real long-term costs. To get the best value from your mortgage points, you should not move or refinance prior to your break-even point.

When will you break even?

It’s important to understand your break-even point with mortgage points. Prior to this point, the cost of your discount point will be greater than the money you’ve saved. But after this point, your total savings will exceed the upfront cost of your points.

How do you know when you will break even? Imagine that you have a $200,000 loan and you receive an interest rate of 4.5%. If you purchase one mortgage point, your loan rate will be reduced to 4.25%, though it will cost you $2,000 to get that reduced rate.

With this plan, your reduced interest rate would save you approximately $29 per month. To find your break-even point, simply divide your upfront cost by your monthly savings.

In this example, the break-even point will be 69 months ($2,000 divided by $29 per month). With one mortgage point, you will need to spend five years and nine months in your home to receive any value from the discounted rate.

Tips for negotiating mortgage points

Some lenders may be willing to work on mortgage point fees, so it never hurts to ask for the best available deal during the negotiation process. Here are some steps you can take as you’re comparing lenders:

• Shop around for lenders that offer the best reduction from mortgage points.
• Apply through multiple lenders and encourage them to compete for your business.
• Check for discounts associated with purchasing multiple points.
• Avoid lenders that cap your mortgage points at a low number.
• Make a larger down payment to keep your principal lower.
• Be careful with points and adjustable-rate mortgages, as points usually only impact the initial fixed-rate period.

Bottom line: Are mortgage points worth it?

Mortgage points reduce your interest rate and lower your monthly mortgage payments. But it takes until the break-even point before the real savings start to kick in. Homeowners who expect to move after a few years can actually lose money by purchasing mortgage points.

Mortgage points may be a good idea if you:

• Have the extra funds available
• Are planning to stay in your home for a long time
• Don’t plan to refinance before the break-even point

Mortgage points are probably not a good idea if you:

• Can’t afford the extra costs at closing, or if the costs would affect your down payment amount
• Plan to move out before your break-even point
• Want to refinance before your break-even point

For more information about mortgage costs, read next about origination fees.