Buying a house comes with a lot of decisions. It can feel overwhelming, especially when options like mortgage points come up. Often referred to as “buying down the rate,” purchasing discount points involves paying the lender a fee to lower your mortgage rate — and therefore your monthly payment. Sometimes lenders also refer to origination fees, a cost associated with loan processing, as “points,” adding to the confusion. To be clear, origination fees — while sometimes negotiable — aren’t optional; discount points are.
What’s the Point?
A point costs 1% of the mortgage amount, and buying one point typically reduces your interest rate by 0.25%. If you were borrowing $400,000 at 8% for 30 years, one point would cost $4,000. For that extra fee, you would likely receive a discount that brings your rate down to 7.75%. Buying two points should reduce the interest rate to about 7.5%.
Here’s how that would affect your monthly payments and cost of ownership in a hypothetical example:
- At 8%, you’d pay $2,935 a month, and a total of $1,056,600 over the life of the loan.
- At 7.75%, you’d pay $2,866 a month, which equals $1,031,760 plus $4,000 for one point, for a total of $1,035,760.
- At 7.5%, you’d pay $2,797 a month, which equals $1,006,920 plus $8,000 for two points, for a total of $1,014,920.
So, buying one point would save you nearly $21,000 over the life of the loan, while two points would save more than $41,500. You should ask your lender to run the numbers on your mortgage to know how much buying points would lower your payment — and your total costs over the life of the loan — with your particular agreement.
Calculate the Breakeven
But what if you don’t anticipate keeping the house for 30 years? This is more complicated because of how mortgages are amortized, which affects the allocation of payments between principal and interest over time. However, the breakeven point — where the cost of the points equals the amount saved on lower monthly payments — is usually about five years on a 30-year mortgage.
If you’re looking to buy down the rate, you can — and should — negotiate points as part of the mortgage process. Some lenders may include points in their calculations by default, which can make their terms look better. When evaluating loan offers make sure they’re directly comparable: Ask the lenders to show their offers with zero points so you’re comparing apples to apples.
You may also be able to buy fractions of points or ask the home seller to pay for your points. If you itemize deductions on your income tax, you may qualify to deduct the cost of discount points on your principal residence; however, you may have to prorate them over the life of the loan. Consult a knowledgeable tax adviser about any deductions you may be entitled to before making a decision.
Other Ways to Save
There are many other ways of lowering monthly payments or the overall cost of your loan:
- If you think you’ll only be in the house for a short time, or you’re willing to bet that interest rates will drop in the future, you might consider an adjustable-rate mortgage (ARM) — but understand that if rates go up, so will your payments.
- If you’re a veteran or active-duty military, a loan backed by the Veterans Administration may offer lower interest rates and a lower down payment if you qualify.
- A 15-year mortgage will raise monthly payments but dramatically lower your total cost: In the example above, monthly payments would rise to $3,823 but the total paid would be $688,140, a savings of $368,460 versus the 30-year loan with no discount points.
- Especially if your credit score is below 700, improving that score can lower your interest rate as much as buying points in some cases.
Stay on Point With Professional Advice
So should you buy the points? It’s not a simple decision. Consult a Financial Professional who can look at your overall situation — income, savings, proposed purchase, down payment, loan terms — and make prudent recommendations. Their familiarity with many kinds of financial products may suggest a strategy that lenders or mortgage brokers can’t.
Sources
Nerdwallet.com, Mortgage Points: Should You Pay These Optional Fees?