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One of the many questions first-time homebuyers ask when they receive their loan estimate is about mortgage points or discount points.
Unless you’re familiar with the mortgage lending process, you probably aren’t aware of what it is and how it impacts your entire home buying journey.
If you’re applying for a mortgage to buy a house or refinance your existing mortgage, buying mortgage points or not can have a considerable impact on the interest rate you receive.
So, you must know the basics of what mortgage points are and how you can use them to your advantage when applying for a mortgage loan.
What Are Mortgage Points?
Also referred to as a mortgage discount point or buying down rates, mortgage points are upfront you pay to your mortgage lender at closing in exchange for a lower interest rate.
Typically, points are priced as a percentage of your mortgage cost (one point equals 1% of the total loan amount).
And each point you pay for lowers your interest rate by a certain percentage that your lender decides.
While buying mortgage points is optional, it can save you thousands of dollars in average monthly mortgage payments over the life of the loan.
How Do Mortgage Points Work?
The workings of mortgage points are relatively simple. Here’s how mortgage points work:
- You agree to pay the lender for a “point.” Each mortgage point usually costs 1% of the total loan amount.
- Your lender then agrees to lower your rate by a certain percentage — typically 0.25%, but it varies by lender.
One upside to buying mortgage points is that you can also deduct them from your taxable income, just like typical mortgage interest rates.
How Much Do Mortgage Points Cost?
The cost you pay for mortgage points is calculated based on how much you’re borrowing. As we mentioned in the earlier section, one discount point costs 1% of the loan amount. So, if you have a $600,000 loan, one point will cost you $6,000.
However, if you have a large down payment, excellent credit score, and low debt-to-income ratio, you may be able to negotiate the amount you pay for each discount point.
Mortgage Points Example
Below is an example highlighting the savings you would make when buying mortgage points versus when you decide not to.
Let’s say you have a 30-year home loan worth $300,000; one mortgage point will likely cost you $3,000. Each point you buy reduces your interest rate by a specific amount — typically 0.25%.
So, after buying one point, a 3.50% interest rate would fall to 3.25%. That might not sound like much, but you would save nearly $12,000 over the life of the loan.
Here’s how two home loans would look with and without points:
|Feature||With Points||Without Points|
|Total Interest Paid:||$136,018||$147,975|
|Total Payment Paid:||$376,018||$387,975|
What Are the Advantages of Mortgage Points?
Below are some advantages of paying for mortgage points on your mortgage:
- The most significant advantage of paying for mortgage points is that it gets you a lower interest rate regardless of your credit score and down payment. And if you plan to keep the mortgage for a long time, a lower interest rate can save you loads of money over time.
- Another key advantage is that mortgage points are tax-deductible. If you decide to itemize your deductions instead of the standard deductions, you can deduct these points from your taxable income.
- Paying for mortgage points can offer you a lower monthly mortgage payment over the life of the loan. Like in our example above, you can see the impact of mortgage points on mortgage payments.
What Are the Disadvantages of Mortgage Points?
As with any mortgage offer, there are several downsides to buying mortgage points.
- You will have to pay a huge chunk of money which may affect the amount you put towards your loan down payment.
- By taking out your down payment to pay for mortgage points, you may have to pay for mortgage insurance if you put down less than 20%
- It will take you a whole lot of time to break even on the money you spent on buying mortgage points. And if you plan on keeping the mortgage for a shorter period, you may not reap the benefits that come with paying down your interest rate.
When Should You Buy Mortgage Points?
Every home buyer loves a lower interest rate. But buying mortgage points may not be the best option for every home buyer. In this section, we’ll reveal when you should consider buying mortgage points.
- You plan on staying in the home for a long time. If you plan on keeping the mortgage for a long time, buying discount points can reduce the overall cost of the loan.
- Your break-even point seems achievable. While buying mortgage points can lower your monthly mortgage payment, but you can only receive this benefit when you hit your break-even point. That is the period where your monthly savings equal the upfront costs of the discount point.
You may be asking; how do I calculate that break-even point? Let’s show you how to calculate your break-even point using the following example.
If you have a $300,000 loan amount, going from a 3.5% interest rate to a 3.25% interest rate saves you $33 per month.
As mentioned earlier, the cost of 1 point on a $300,000 loan amount is $3,000. If you divide the upfront cost of the points by your monthly savings, you’ll find that your break-even point is about 82 months ($3,000/$33 equals 91), which is equal to roughly seven years and five months.
So, if you plan on keeping your mortgage for longer than that amount, then buying mortgage points may be a great decision.
When Should You Not Buy Mortgage Points?
Here are some reasons why buying mortgage points may not be a great decision:
- You don’t intend to stay in the home for long. If you’re in the military or love to move from place to place, buying mortgage points may not be beneficial.
- You plan to make additional payments on the loan. If you’re financially capable with the means of making extra payments on your mortgage, buying mortgage points might seem like a waste of money.
- You don’t have the finance to buy mortgage points. Mortgage points can be expensive. It is not financially wise to splurge your savings to save on interest down the line. Instead of spending your savings on mortgage points, you could channel it to paying down your mortgage principal.
- It will impact your down payment. Most mortgage experts will advise that you channel your saving towards your down payment. Bigger down payment will mean lower monthly mortgage payments, lower interest rates, and even no mortgage insurance costs.
What Are Mortgage Origination Points?
There is another type of mortgage point called mortgage origination points. If you’re a first-time homebuyer, you may not be familiar with mortgage origination points and how it works.
Mortgage origination points are fees homebuyers pay to online mortgage lenders for originating, reviewing, and processing their loans. So, if
Generally, mortgage origination points cost around 1 percent of the total mortgage amount.
So, if your lender charges you two origination points for processing a $400,000 loan, then you will have to pay $8,000. While mortgage points are optional, mortgage origination points are compulsory.
Can You Buy Mortgage Points for Adjustable-Rate Mortgages?
While it is possible to buy mortgage points for adjustable-rate mortgages (ARM), it only provides a discount on the initial fixed period (five to seven years) of the loan and isn’t generally done.
So, buying mortgage points for an ARM may not be the wise thing to do. However, it would be best you discuss this with your lender for proper guidance.
Can You Negotiate Points on a Mortgage?
Yes, you can negotiate the amount you pay for a point on your mortgage loan. It is common for lenders to reduce the price a borrower pays for mortgage points with a high credit score and down payment. By negotiating the amount, you can save more money over the loan term.
Are Mortgage Points Tax Deductible?
Just like other mortgage interest you pay during a particular tax year, you can deduct mortgage points from your taxable income when you itemize them using Schedule A of Form 1040. Discount points paid on a home purchase mortgage loan can be 100% deductible in the year they’re paid.
Discount points on a home refinance mortgage loan cannot. If you had spent a huge sum of money on mortgage points at closing, then you are most likely in for a substantial write-off when tax season comes.
>> More: What Is Mortgage Interest Deduction?
Can You Buy Discount Points After Closing?
No, the terms of your loan are set before closing. When you sign that truckload of paperwork, the deal is done, and you can only refinance to get a lower interest rate.
Bottom Line: Mortgage Points
There are a lot of factors that go into whether or not you should purchase mortgage points to beat down the interest you pay over the life of the loan.
Before settling for one, you should do the math, assess your financials and future housing plans before you close on the mortgage.
More importantly, you should find out your break-even point and the possibility of you staying in the house up to or more than the break-even period.