Mortgage points are a way to lock in a lower interest rate during the homebuying process and pay less on your loan over time. You can use this handy guide to understand exactly what are mortgage points, how they’re calculated, and to gauge whether buying down your interest rate makes sense for your situation.
What are mortgage points and how do they work?
When it comes to purchasing or refinancing your home, locking in a lower interest rate is one way to help you save on your loan over time. One way to do so is to purchase mortgage points. Sometimes referred to as discount points, mortgage points are fees borrowers pay to their lender in exchange for lowering their mortgage interest rate. This upfront fee will affect your mortgage closing costs, but may save you money in the long run.
Mortgage points are different from lender credits — think of them as opposite of sorts. Lender credits is a discount or money that goes towards lowering your closing costs and calculated as negative points. For example, if a lender offers you a $2,000 credit on your $200,000 mortgage, it may be referred to as negative one point. However, lender credits may increase your interest rate — the more you get, the higher your rate may be.
Keep in mind purchasing points with one lender may not always result in the lowest rates — other lenders may offer more competitive rates without needing to charge points. That’s why it’s a smart idea to shop around with multiple lenders to find the best option for you.
How much do mortgage points cost?
Each discount point on a mortgage costs 1% of the amount you borrow. For example, if your mortgage is for $350,000, one point will cost you $3,500. This amount will be added to your closing costs. With most lenders, each point will lower the interest rate by 0.25% — check with yours to see if that’s the case. That means if your home loan has an interest rate of 3.75%, purchasing one point lowers it to 3.50%.
Take a look at the chart below to see an example of the long-term cost impact of paying points on a mortgage based on a $300,000 30-year loan:
|No Points||One Point||Two Points|
|Savings after five years||N/A||$2,580||$5,100|
Purchasing points may be worth it if you can afford the upfront costs and plan on staying in your home for a long period of time. The longer you stay and the less likely you are to refinance your home in the next few years, the more you’ll be able to reap the benefits of purchasing points. If you’re unsure how long you plan on staying, it’s best to speak with your loan officer to compare your loan options.
Is it worth buying points? Calculating your breakeven
As you’re considering whether buying points on a mortgage is a good idea or not, thinking about your breakeven point is helpful. That’s because the breakeven point shows you how long it’ll take to recoup the money you paid to purchase points. You want to be able to make the fees worth it — as in, you want to save as much as you can on interest payments — so the longer you stay past your breakeven point, the better.
To calculate the breakeven point, take the amount you paid in mortgage points and divide it by the amount you’ll save each month. Using a mortgage calculator will help you determine the amount you’ll save each month. For example, you’ll pay $3,000 to buy down the interest rate and save $43 per month.
Here’s how the calculation works out:
$3,000/$43 = 69.8 months
This means for you to break even, you’ll need to remain in your home for at least 70 months to start truly saving in interest on your mortgage.
Determining whether you want to purchase points as you’re going through the homebuying process will ensure you’re saving as much as possible on a mortgage. Purchasing points usually makes sense if you have enough cash to purchase them upfront. Remember, you’ll have to pay these with your closing costs.
Plus, consider how long you plan on staying in your home. If you know you won’t stay in the home after your breakeven point, then purchasing points might not be worth it.
Instead, consider alternatives like using the extra cash to pay down your principal or using it to make a larger down payment. Both these options may help you save some money on interest payments.
Mortgage points tax deduction
Are mortgage points tax deductible? That depends.
Under certain circumstances, you may be able to qualify for a tax deduction on your mortgage points. According to the IRS, you’ll need to itemize your deductions on Form 1040, or Schedule A and it’ll count as part of the mortgage interest you deduct for the year you paid them. You may be able to deduct all of it, or up to the limit imposed by your filing status.
You may also be able to deduct mortgage points ratably over the lifetime of your mortgage if you can meet certain conditions. To be able to deduct points in full in the year paid, you’ll also need to meet other conditions such as the mortgage is for your primary residence, you paid for the fees with your own money, and what you paid isn’t more than what’s typically charged by lenders in your area.
When it comes to buying mortgage points, it could be worth it under certain situations, such as staying past the breakeven point or using them for certain types of home loans. Doing so can save you thousands of dollars over the life of your mortgage.
Before signing on the dotted line, make sure you understand whether the benefits outweigh the fees you’ll pay. That’s why shopping around and speaking with an experienced mortgage professional will help you make an educated decision as to whether paying upfront in the hopes of saving money is worth it.
If you’re ready to start shopping for a mortgage loan, talk to a Finance of America Mortgage Advisor today to learn more about your options.