You may hear several terms when lenders talk about this concept, including points, discount points, or mortgage points. All of these terms refer to the same idea. Mortgage points are a way to pay prepaid interest on a loan in exchange for a lower interest rate.
When you buy points, you make a one-time payment at closing. In return, the lender reduces your mortgage interest rate. This reduction can lower your monthly payment and reduce the total interest you pay over the life of the loan.
How mortgage points work
Mortgage points follow a simple formula. One point equals one percent of the loan amount. For example, if you take out a $200,000 mortgage, one point costs $2,000. Two points cost $4,000. As the loan amount increases, the cost of points increases as well.
Points do not reduce your loan balance. They only lower your interest rate. Because of that, points make the most sense when you plan to stay in the home long enough to recover the upfront cost through monthly savings.
How much points reduce your interest rate
Interest rates change daily, so there is no fixed rule for how much a point lowers your rate. In most cases, one point reduces the rate by about 0.25% to 0.375%. The exact reduction depends on market conditions, the lender, and your financial profile.
Before buying points, ask your lender to show you the payment difference with and without points. This comparison helps you see how long it takes to break even.
When buying points makes sense
Buying mortgage points works best when you plan to stay in your home for many years. The longer you keep the loan, the more value you get from the lower interest rate. If you expect to sell or refinance within a few years, points may not make financial sense.
You should also consider your cash needs at closing. Points add to your upfront costs. If you need funds for repairs, improvements, or moving expenses, you may prefer to keep that cash instead of spending it on points.
Avoid buying too many points. Paying extra upfront does not reduce your loan balance, and you may never recover the cost if you move too soon.
Tax considerations
Discount points may qualify as a tax deduction in the year you purchase them. Tax rules vary, so always consult a tax professional before claiming a deduction. A qualified advisor can confirm whether your points meet the requirements and how to report them correctly.
Origination points vs discount points
Mortgage points fall into two categories: origination points and discount points. Origination points are lender fees for processing your loan. These points do not reduce your interest rate and are not tax deductible. Lenders often charge one to two origination points, though you can sometimes negotiate them.
Discount points, on the other hand, exist solely to lower your interest rate and may qualify for tax benefits.
Final takeaway
Buying discount mortgage points can save a significant amount of money over the life of a loan when used correctly. The key is timing, planning, and understanding your long-term goals. Review your options carefully and work with your lender to decide whether points benefit your mortgage strategy.
In all, buying discount mortgage points can save you a significant amount of funds during the length of your loan. Take a look for yourself and see how your mortgage can benefit.
