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Mortgage Points: What to Know Before You Pay

Learning about mortgage points

An interest rate can make or break the affordability of a mortgage. One way to get a lower rate and save money on your loan upfront is by paying for mortgage points.

Paying points on a mortgage reduces your interest rate, which results in a lower monthly mortgage payment and a less expensive loan overall.

This article will help you understand points and how they can affect your home loan costs.

We’ll cover:

What are mortgage points?

Mortgage points are fees paid upfront to a mortgage lender to buy down the loan’s interest rate. Each mortgage point costs 1% of the loan amount. On a $200,000 loan for example, one point would cost $2,000.

One category of mortgage points, called discount points, are used to buy down the interest rate and receive a lower monthly mortgage payment. As a homebuyer, each point you purchase can drop your mortgage rate by anywhere from one-eighth (0.125%) to a quarter (0.25%) of a point, said Pava Leyrer, chief operating officer at Northern Mortgage Services in Grandville, Mich. However, interest rate reductions vary by lender.

Other points, which might be referred to as origination points, are used to express how much a mortgage lender charges to originate a loan. They’re calculated the same way as discount points and are added to closing costs. However, they don’t provide a benefit to homebuyers.

You’ll see information about any points you’ve purchased on your Loan Estimate after you’ve submitted an application, and again on your Closing Disclosure.

How do mortgage points work?

As previously mentioned, you pay for any mortgage points your lender charges at the closing table — in addition to your other closing costs. Let’s look at an example of how paying points on a mortgage can affect your overall loan costs, using a 30-year, $200,000 loan and assuming each point reduces the interest rate by 0.25%.

0 points  1 point  2 points 
Points cost  $0 $2,000 $4,000
Interest rate  4.5% 4.25% 4%
Monthly payment 

(principal and interest)

$1,013.37 $983.88 $954.83
Total interest paid  $164,813.42 $154,196.72 $143,739.01

 

As the table shows, buying one point only reduces your monthly mortgage payment by about $30, while two points lowers your payment by nearly $60.

Should you buy mortgage points?

When should you consider buying points on a mortgage? The answer depends on your specific circumstances.

A major consideration is whether you have cash to pay mortgage points on top of your down payment and other closing costs. Depending on your loan amount, paying for points can get pricey.

You’ll also want to determine how many points you’d like to buy. Leyrer said she rarely comes across borrowers who purchase more than two points.

“It ends up not being worth it because you diminish your return the more you go,” she said.

Pros and cons of buying points

Still weighing the decision? Here’s a look at the advantages and disadvantages of buying points:

Pros  Cons 
  • You’ll reduce your mortgage interest rate.
  • You’ll have a lower monthly mortgage payment.
  • There will be a decrease in the total cost of your loan.
  • You may qualify to deduct the points at tax time.
  • Points can cost several thousand dollars.
  • Your closing costs will be higher.
  • You’ll need to stay in your home for several years in order to break even on the points paid.
  • You lose your money if you sell your home before breaking even.

 

Regardless of why you’re considering points, factor in how long you plan to stay in your home. It generally takes a few years to recoup point costs, regardless of the size of the loan amount. To determine your break-even point, divide the points cost by the monthly payment savings, and you’ll get the number of months you need to stay in your home to recoup the added costs.

Using the $200,000 loan example above, it would take just under six years to break even on both a one-point and two-point purchase.

Are mortgage points tax-deductible?

You may be able to take advantage of a mortgage points tax deduction. If eligible, you can deduct the cost of your points, along with your interest payments. 

In most cases, you’ll deduct the amount you paid in points over the life of your loan, but there’s an option that allows you to deduct the full amount in the year you paid them. To qualify for this option, you’ll have to meet nine requirements outlined by the Internal Revenue Service.

Questions to ask before buying points

Mortgage points cost money and add to your total closing costs, so it’s important to fully understand how they’ll benefit you before you make the commitment. Ask and get answers to the following questions before you decide on buying points for a home loan:  

  • How much do mortgage points cost?
  • How much will you save on your monthly payment with points?
  • Can you immediately afford to pay for points?
  • How long do you plan on living in your home?
  • Will you break even on this cost before you sell your home?
  • Can a different lender offer you a comparable interest rate without paying for points?
 

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