What Are Mortgage Points and How Do They Work?

Buying a home comes with a lot of new terms, and one of the most confusing is mortgage points. You’ll likely hear lenders mention them when they talk about your interest rate or monthly payment. But what exactly are they? And are they something you should pay for?

Mortgage points are essentially a way to “buy” a lower interest rate upfront. Think of them as a trade-off: you pay more now to save money over time. For some buyers, this can mean big long-term savings. For others, it might not be worth the upfront cost.

Let’s break down how mortgage points work, how much they cost, and how to know if they make sense for your situation.

What Are Mortgage Points?

Mortgage points are optional fees you can pay your lender when you take out a home loan. They help manage the overall cost of your mortgage. There are two kinds of mortgage points: origination points & discount points.

• Origination Points: These points are basically fees paid to the loan lender for processing and approving your loan. Some lenders charge them, while others offer low-fee or no-fee options. These points do not reduce your interest rate and are not tax-deductible.
• Discount Points: These points let you pay up front to lower your interest rate. This can lower your monthly payments & the total interest you pay over time. Typically, one discount point can lower your rate by about 0.25%, though the exact amount varies. You can purchase part of a point or several points, depending on what works for your budget. Discount points may also be tax-deductible on many home loans (up to certain limits). To know for sure, it’s smart to check with a tax professional.

How Mortgage Points Work

Generally, one point equals 1% of your loan amount and usually lowers your rate by about 0.25%.

So, on a $500,000 mortgage:

• 1 point = $5,000 upfront
• Paying that point might reduce your rate from 6.5% to 6.25%

The exact discount can differ between lenders, so it’s important to ask your loan officer how much of a rate drop you’ll receive for each point.

You don’t have to buy a full point; you can also purchase partial points.For example:

• 0.5 point = $2,500
• And might reduce the rate by around 0.125%

The cost of these points will show up on your closing paperwork as “prepaid interest.”

Example of How Points Affect Payments

Scenario	Cost for Points	Interest Rate	Monthly Payment (P&I)	Total Interest Paid Over 30 Years
No Points	$0	7%	≈ $3,326/month	≈ $697,545
1 Point	$5,000	6.75%	≈ $3,242/month	≈ $667,476
2 Points	$10,000	6.50%	≈ $3,160/month	≈ $637,723

In this example, paying for two points costs $10,000 upfront, lowering the monthly payment by about $166. It also reduces the total interest paid over the life of the loan by approximately $59,800. However, you only gain those full savings if you keep the mortgage for the entire 30-year term.

Understanding the Break-Even Point Calculation

To figure out whether buying points makes sense, calculate how long it takes for the monthly savings to equal the upfront cost.

Break-even formula:

Cost of Points ÷ Monthly Savings

For this $500,000 example:

$10,000 ÷ $166 ≈ 60 months

That means it would take around 5 years to break even.

If the borrower sells the home or refinances before those 5 years, they may not recover the upfront cost of buying the points.

Pros and Cons of Mortgage Points

Mortgage points come with advantages and disadvantages. Let’s get into them in detail: 

Pros of Buying Mortgage Points

1. Lower Monthly Mortgage Payments

By purchasing points, you reduce your interest rate, which directly lowers your monthly payment. Even a small decrease in your rate can make your mortgage more affordable month to month, making it easier on your budget.

2. Pay Less Interest Over the Life of the Loan

As your interest rate is lower, you end up paying less interest in total. Over a 30-year mortgage, this can add up to thousands of dollars in savings, especially if you plan to stay in the home long term.

3. Possible Tax Benefits

In some situations, the cost of mortgage points can be tax-deductible because they are considered prepaid interest. However, this depends on your specific tax situation, so it’s a good idea to speak with a tax professional to see if you qualify.

Cons of Buying Mortgage Points

1. Requires More Money Upfront

You’ll need extra cash at closing to pay for the points in addition to your down payment and other closing costs. If money is tight when you’re buying a home, paying for points may not be practical.

2. Savings Only Make Sense If You Stay in the Home Long Enough

The financial benefit of buying points comes over time. If you sell the home, refinance, or pay off the loan early, before the monthly savings add up to the amount you paid for the points, you could end up losing money. That’s why knowing your break-even point is so important.

Is Buying Mortgage Points Worth It?

As of now, interest rates are higher than ever, which makes buying mortgage points sensible. However, due to elevated home prices, you might realise that the break-even point is equal to or more than 5 years in the future. The longer it takes to recover the cost of mortgage points, the more mindfully you must consider buying them. Careful consideration becomes even more necessary when rates are going down, as you might want to refinance to lower rates. 

For some homebuyers, this may not feel worthwhile, especially if refinancing feels time-consuming or the potential monthly savings seem too small.

When Does Buying Mortgage Points Make Sense?

• Staying Long-Term: Since mortgage points permanently lower your interest rate, the longer you keep your loan, the more value you get. If you plan to live in the home for many years, the savings gained over time can outweigh the upfront cost.
• No Plans to Refinance: If you’re likely to refinance before you hit your break-even point, paying for points may not make sense. The savings only continue to benefit you as long as the original mortgage stays in place.
• Compare With Extra Down Payment: Before committing, run the numbers. Sometimes, putting extra cash toward a larger down payment may reduce your loan balance in a more meaningful way. In other cases, lowering your interest rate with points provides greater overall savings. The right selection depends on your long-term plans & financial comfort.

Conclusion

Mortgage points can be a smart choice to lower your interest rate & save money over the life of your loan, but they’re not the right fit for everyone. The key is understanding your long-term plans. If you’re confident you’ll stay in the home for several years and you’re comfortable paying more upfront, points can offer meaningful savings. But if you expect to move, refinance, or want to keep more cash on hand now, it may be better to skip them.

Every homebuyer’s situation is different, and having the right guidance makes all the difference.

If you’d like help running the numbers or exploring whether buying points makes sense for your financial situation, Total Mortgage’s loan experts are here to walk you through it step by step. We’ll help you compare scenarios, understand your break-even point, and choose the option that aligns with your goals.

Ref: https://www.bankrate.com/mortgages/mortgage-points/#when-is-it-a-good-idea