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What Are Mortgage Points? Should You Buy and How To Calculate

TLDR

What You Need To Know

  • Mortgage points can help you access lower interest rates – cha-ching!
  • You pay for points when you close on your mortgage
  • One mortgage point costs 1% of your total mortgage amount

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Have you ever wondered whether you should buy mortgage points? If this is your first time buying a home, we wouldn’t be surprised if you were asking yourself just what exactly a mortgage point is.  

You see, many home buyers are known to experience intense happiness and excitement after learning that they’ve been approved for their home loan. That feeling of euphoria can take a dive once soon-to-be homeowners start thinking about their monthly mortgage payments. 

Mortgage points (or discount points) are your lender’s way of helping you keep those good vibes going for a lot longer. 

Mortgage points help you unlock a lower interest rate on your mortgage loan. The lower rate will reduce your monthly payment, freeing up cash each month and saving you thousands over the life of your loan.

You may be ready to pull out your checkbook, but like anything else, it’s important to consider the pros and cons of buying mortgage points. See what the advantages and the disadvantages are before you make any decisions.

What Are Mortgage Points?

Mortgage points allow you to buy a lower interest rate than the one that you originally qualified for. One mortgage point usually reduces your mortgage interest rate by 0.25%. 

You can typically purchase mortgage points upfront when you close on your mortgage.

Every point you buy represents 1% of your loan amount. So, for example, if you’re taking out a $250,000 mortgage, one mortgage point will be equal to $2,500. Each point can drop the initial interest rate by 0.25%.

It’s important to understand that points don’t reduce the principal amount of your loan (aka the total amount you borrowed) – they only reduce the interest. 

On paper, 0.25% might not look like much. But let’s do the math. If you’ve got a 30-year, $250,000 mortgage with a 4% interest rate, you’ll pay more than $179,674 in interest by the end of your term (or loan repayment period). 

With one mortgage point, you can reduce your rate to 3.75%, bringing your total interest down to $166,804. That’s a savings of nearly $13,000!

With four mortgage points, which is typically the highest number of points most lenders will sell, you can lower your interest rate to 3%. You’d end up paying $129,444 in interest over your loan term. You would significantly reduce your monthly mortgage payments and the total amount spent on your loan.

Are you ready for the plot twist? 

Even though your monthly mortgage payments will be lower with mortgage points, your upfront cost to buy the home is going to be a lot higher. 

If you’ve got the extra cash to spend when you close on your mortgage and you can’t get the idea of lower monthly mortgage payments out of your head, speak to your mortgage broker or lender about buying mortgage points. 

If you’ve already applied for a loan, check your Loan Estimate and see what your lender can offer. If you decide to buy points, you’ll find your points and related details on your Closing Disclosure.

How Mortgage Points Work

Let’s rewind.

You applied for your mortgage and got approved (congrats, BTW!). Next, you get several loan offers from your lender with different terms and APRs. 

This is the moment of truth. This is when you’ll decide whether to buy discount points. And it’s also when you’ll decide between a fixed or adjustable-rate mortgage (ARM).

If you go with a fixed-rate mortgage, your mortgage point(s) will keep your interest rate lower for the life of the loan. If you go with an ARM, your point(s) will keep your interest rate lower until the end of the ARM’s introductory interest rate period, which is typically 5 – 7 years. 

If you’re considering an ARM, you’ll need to know your breakeven point to decide if buying mortgage point(s) is even worth it.

Your breakeven point is the amount of time you need to live in the house to recover the cost of your mortgage point(s). To calculate this, you’ll have to divide the total cost of your points by the reduction in your monthly mortgage payment.

Let’s say you get a loan for $250,000 and buy two mortgage points for $5,000. The savings on your monthly mortgage payments would be $71.

$5,000 / $71 = 70.4 months

So, your breakeven point would be a little over 70 months, which is close to 6 years. If you’re not going to stay in the house that long, buying mortgage points might not make sense for you.

How To Negotiate Mortgage Points

Can you negotiate points on a mortgage? In some cases, yes! While the lender makes the final decision, you can boost your chances of getting a yes by: 

  • Boosting your credit score
  • Throwing big money at that down payment (at least 20%)

Negotiating may be a nonstarter if your credit score isn’t 750 or higher and you’re making a down payment of less than 20%. 

When Buying Mortgage Points Could Make Sense

If you’re looking to build equity faster or pay off the principal balance of your loan sooner, mortgage points aren’t typically the way to do it. If that’s the goal, either make a larger down payment or make higher monthly mortgage payments.

Still, there are a few scenarios where buying mortgage points may make sense:

  • You plan to live in your new home long enough to make it past the breakeven point
  • You want to reduce your monthly mortgage payment
  • You have a low credit score, but a lot of cash saved up, and can’t qualify for lower interest rates
  • You have extra cash to spend and you want to take advantage of tax deductions

Deducting Mortgage Points on Your Taxes

So you said yes to the discount. That’s great! And do you know what else is great? Discount points are tax-deductible!

You can deduct your mortgage discount points on home loans of up to $750,000.[1]

But before you start filling out your tax return, get familiar with the IRS mortgage interest deduction requirements to get the most out of your returns. 

Most homeowners can only claim deductions for points paid toward that calendar year’s mortgage interest, so this tax deduction may need to be claimed annually for as long as you’re in the house.[1]

Most lenders will send borrowers a Form 1098 before tax season starts. This form shows you how much you paid in mortgage points, as well as how much you paid in interest that year. You can record this information on Schedule A of the Form 1040, which is your itemized deduction form.

Discount Points vs. APR vs. Origination Points

There are two kinds of mortgage points: discount points and origination points. We’ve already talked about discount points, so let’s dive into origination points.

Like a discount point, one origination point is equal to 1% of the total loan amount. But, unlike a discount point, origination points don’t reduce interest. They act as a lender credit, going toward lender fees and other costs, like a loan origination fee, processing costs and credit inspection fees. Like discount points, origination points are also paid at closing. But in another departure from mortgage points: Origination points are not tax deductible.

Annual percentage rate (APR) is a term you’ll likely hear a lot during the mortgage approval process, and it’s an important concept to understand. The APR reflects the total cost of your home loan, including points, interest and any fees from the lender.

Here’s 1 Point From Us for Learning About Mortgage Points

Okay, you got us. Our point won’t reduce any interest rates or lender fees. Our point was to help you navigate the world of mortgage points and help you make informed decisions. 

If you want to reduce the overall cost of your loan or keep your monthly mortgage payments low, mortgage points might make sense for your wallet. Just make sure the upfront costs won’t put your present-day budget or your future financial goals at risk.

  1. Internal Revenue Service. “Publication 936 (2020), Home Mortgage Interest Deduction.” Retrieved November 2021 from https://www.irs.gov/publications/p936#en_US_2020_publink1000229939

ICYMI

In Case You Missed It

  1. Mortgage discount points are tax-deductible – origination points are not

  2. If you have an ARM, your points apply until your interest rate adjusts at the end of the introductory rate period

  3. To figure out if buying mortgage points are worth it, you need to decide if you’ll live in the house long enough to break even

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