How Mortgage Points Work and When to Buy Them

How Mortgage Points Work and When Buying Them Saves You Money

When you get a mortgage quote, you will almost certainly see the option to buy "points." The concept is simple: you pay money upfront at closing in exchange for a lower interest rate for the life of the loan. But deciding whether points are worth it requires some math and a realistic look at how long you plan to keep the mortgage.

What Exactly Are Mortgage Points?

One mortgage point equals 1% of your loan amount. On a $400,000 mortgage, one point costs $4,000. On a $600,000 mortgage, one point costs $6,000.

There are two types of points, and they serve different purposes:

• Discount points: These are what most people mean when they say "buying points." You pay upfront to reduce your interest rate. Each point typically lowers your rate by 0.25%, though this varies by lender and market conditions.
• Origination points: These are lender fees for processing your loan. They do not lower your rate. They are simply a cost of getting the mortgage. When evaluating loan offers, make sure you know which type of points you are looking at.

This article focuses on discount points — the ones you choose to buy to save money over time.

The Break-Even Calculation

Buying points is straightforward math. You need to figure out how long it takes for your monthly savings to recoup the upfront cost.

Here is a real example. Say you have a $400,000 loan and you are offered 6.75% with no points, or 6.5% with one point ($4,000).

• Monthly payment at 6.75%: $2,594
• Monthly payment at 6.5%: $2,528
• Monthly savings: $66
• Break-even: $4,000 / $66 = approximately 61 months, or about 5 years

If you keep the loan for at least 5 years, buying the point saves you money. If you sell or refinance before that, you lost money on the deal.

When Buying Points Makes Sense

You plan to stay in the home long-term. If this is your forever home and you intend to keep the mortgage for 10, 15, or 30 years, buying points almost always pays off. In the example above, over a 30-year term you would save roughly $19,800 in interest for a $4,000 upfront investment.

You have excess cash at closing. If you have already hit your target down payment and still have cash available, points can be a better use of that money than sitting in a savings account. Just make sure you maintain adequate emergency reserves.

You are in a high tax bracket. Mortgage points are generally tax-deductible in the year you pay them (for a purchase) or over the life of the loan (for a refinance). If you itemize deductions, the effective cost of buying points is lower than the sticker price.

Rates are high and you expect them to stay elevated. If you believe rates will remain high for years, locking in a lower rate through points makes more sense than hoping to refinance later.

When Buying Points Does Not Make Sense

You might move within 5 years. If there is a reasonable chance you will sell the home or relocate before the break-even point, you will not recoup the upfront cost.

You expect to refinance soon. If rates are historically high and likely to drop, you may refinance within a few years. Buying points on a mortgage you plan to replace is throwing money away.

It stretches your cash reserves. Points should never come at the expense of your emergency fund, moving costs, or home repair budget. Having a slightly higher rate but a healthy savings account is better than a lower rate and no financial cushion.

The seller is offering closing cost credits. In some markets, sellers offer to cover closing costs. You might be better off negotiating a lower purchase price or using seller credits for other closing costs rather than buying points.

Fractional Points

You do not have to buy a full point. Many borrowers buy half a point or a quarter point. If one point on your $400,000 loan is $4,000, half a point is $2,000 and might reduce your rate by 0.125%. This lets you fine-tune the trade-off between upfront cost and monthly savings.

Negative Points (Lender Credits)

The concept works in reverse too. You can accept a higher interest rate in exchange for a lender credit that reduces your closing costs. This is sometimes called "negative points."

If you are short on closing cash or plan to refinance within a few years, a lender credit can make sense. You pay a slightly higher rate but walk into closing with less out of pocket.

How to Compare Offers with Different Point Structures

When shopping for mortgages, you will get quotes with different combinations of rates and points. The only way to compare them apples-to-apples is to calculate the break-even point for each option and match it against your expected holding period.

Ask each lender for quotes at three levels: no points, one point, and negative points (lender credit). This gives you a clear picture of the trade-offs and lets you choose the structure that matches your timeline.

Want to see exactly how points affect your monthly payment? SOMA can run the numbers on different point scenarios for your specific loan amount and rate. Try it at heysoma.ai.