Mortgage points: What they are and how they work

When you own a home, your interest rate can play a key role in how much you pay for your mortgage. Generally, a higher interest rate means you’ll pay more over the life of the loan. 

But mortgage points could be one way to lower your interest rate. They involve paying the lender a fee at the closing table in exchange for a lower interest rate. Monthly mortgage payments shrink accordingly, which can save you money in the long run. There are instances when buying points can make sense, but it’s a good idea to first consider all the factors.

Key takeaways

• Mortgage points are optional fees paid to the lender to lower the interest rate. And they can be tax deductible. 
• To see if mortgage points are worthwhile, you could calculate your break-even point—when all of your monthly savings outweigh the costs.
• It’s also a good idea to consider what type of interest rate you have, the size of your down payment and whether you have enough money to pay for points.

Mortgage points, sometimes referred to as mortgage discount points, are fees you can choose to pay your lender in exchange for a lower interest rate. The lender shaves a certain amount off your mortgage rate and includes the fee in your closing costs. This practice is sometimes called “buying down the rate,” and it can help lower monthly mortgage payments. 

The cost of a mortgage point is calculated as a percentage of the loan amount. One mortgage point is equal to 1% of the loan amount. So, on a $300,000 home loan, one point would cost $3,000. The amount you’d save with each point varies with the lender, loan and market conditions, but it’s usually around 0.25%. 

Discount points vs. origination points

While discount points are optional costs paid upfront to lower the interest rate, origination points are mandatory—if the lender charges them—and don’t affect the rate. Origination points, also known as origination fees, are what the lender may charge to pay for the costs of things like underwriting and approving your mortgage application. 

When a lender gives you a loan estimate, they’re required by law to list the costs you’ll pay at closing. Those costs may include origination fees and discount points, and you’ll find them listed on Page 2 of the form under “loan costs.” Some lenders don’t charge origination fees, so you may be able to avoid them by shopping around. 

Discount points vs. lender credits

Lender credits work the opposite way of discount points. With lender credits, the lender provides money to offset the closing costs in exchange for a higher interest rate. While you pay less at the closing table, your interest costs are higher over the life of the loan. Lender credits aren’t mandatory, so you may want to ask about other options if you don’t want to pay a higher rate.

Like discount points, lender credits are calculated as a percentage of the loan amount. One “negative point” is equal to 1% of the loan, so it would be $3,000 on a $300,000 loan. The amount the interest rate increases will vary, depending on the lender, type of loan and market trends. If you agree to accept lender credits, they should be listed on Page 2 of your loan estimate.

When you’re shopping for mortgage rates, a lender may offer you a certain interest rate based on your credit profile and financial standing. And you might have the option of lowering that rate by purchasing mortgage points. 

As you know, you can expect to pay 1% of your loan amount for each point you buy, and one point will usually lower your rate by 0.25%. For example, on a home loan of $300,000 with an interest rate of 6%, you could buy two mortgage points for $6,000 in exchange for a rate of 5.5%.

You might want to ask the lender to give you a rate estimate with and without discount points. That way, you can run the numbers to see if the upfront cost is worth the lower rate. 

Take a look at one example of how discount points can reduce a borrower’s monthly payments and interest costs. This is for a $300,000 mortgage with a 30-year, fixed-rate term and a 20% down payment. Here’s how it would compare with no discount points versus purchasing two discount points:

Are mortgage points tax deductible?

Mortgage points are tax deductible. But there are some IRS eligibility requirements that include itemizing tax deductions on Schedule A instead of taking the standard deduction. The deduction is also limited by the amount of your home loan and the date you closed on the mortgage.

The IRS has more rules you may need to follow. Check IRS Publication 936 for details. 

When you buy mortgage points, you’re paying more upfront for a lower monthly payment. So it’s a good idea to make sure the upfront costs are worth the discount you receive. 

You might want to consider:

• How long you’ll stay in the home. Buying down your rate could make sense if you plan to own your home after reaching the “break-even point.” That’s the point when all the money you’ve saved on your mortgage payments equals the cost you paid for the discount points. You can calculate this by dividing what you’ll pay for mortgage points by the amount you’ll save each month. So if you pay $6,000 for discount points to lower your monthly payment by $76, then it will take you 79 months—or about 6.5 years—to recoup the cost of buying points. 
• Whether you’ll move or refinance soon. Refinancing involves replacing your current loan with a new one, which means you’ll have a new interest rate. If you decide to sell the home or refinance your mortgage before your break-even point, then you won’t save money by buying points.
• If you can afford the points. Depending on your loan size and how many mortgage points you purchase, the fees can add up. Consider whether buying points would increase your risk of becoming house poor, which means you’re spending a big portion of your total income on owning a home. Before buying points, it’s a good idea to check whether you have enough in your savings to cover any financial emergencies. 
• The size of your down payment. If your down payment is less than 20% on a conventional loan, your lender will typically require you to buy private mortgage insurance (PMI). And PMI could increase your monthly mortgage payments. Based on how much cash you have, you might consider putting your money toward a larger down payment rather than buying points. 
• Whether the rate is fixed or variable. Some mortgages have an adjustable rate where the interest rate is fixed for only a certain period of time—usually around five to seven years. When that ends, the rate can change periodically. You can buy discount points when taking out an adjustable-rate mortgage (ARM) or a fixed-rate mortgage. But the points typically only apply to the initial fixed-rate period of an ARM, so it’s a good idea to see if the upfront costs will pay off within that time frame. 
• Your loan term. Similarly, you might want to consider whether buying discount points makes sense when comparing loan terms. If your break-even point is 16 years into the loan, for example, then you wouldn’t save money if you have a 15-year loan.

Whether mortgage points are worth considering can be an important question to ask when buying a house. Because mortgage points come with an upfront cost, it’s a good idea to consider your financial goals and calculate your break-even point. Generally, if you plan to be in your home after that point, then you’ll save money. But also consider whether you should instead use the money toward your down payment, the type of interest rate you have and whether you think you’ll refinance at some point. 

And keep in mind, there’s no one right answer for every situation. The decision ultimately comes down to what you decide is in your best interest.