Buying a home is a major life milestone, and it's almost always the most expensive purchase anyone makes. This is especially true right now considering housing prices are through the roof. According to a report from the National Association of Realtors (NAR) published in April of 2022, the median sales price for existing homes rose to $375,300 that month, up 15% from one year before.
With that in mind, mortgage points have the potential to help you lock in a lower interest rate, which can help you pay less for a home over time. Points also become more important when mortgage rates are on the rise like they are right now. The fact is, the Federal Reserve recently approved an interest rate hike of .25% and announced up to six more rate hikes over the next year.
Whether you're searching for a new home to purchase or wondering if you should refinance your mortgage before rates go up again, read on to learn how mortgage points work, how much they cost, and when it makes sense to use them.
What are mortgage points?
A mortgage point — also called a discount point — is a type of fee you can pay in order to lower the interest rate on your home loan. Keep in mind that points are optional, so you don't have to use them as a tool for a lower interest rate if you don't want to.
Also note that some mortgage lenders will cap the amount of points you can buy. Otherwise, you could technically buy points until your interest rate was 0%. It may also be possible to purchase a fraction of a point, which would lower your interest rate by a corresponding amount.
How mortgage points work
According to the Consumer Financial Protection Bureau (CFPB), points effectively allow you to make a tradeoff between your upfront costs and your monthly mortgage payment.
"By paying points, you pay more upfront, but you receive a lower interest rate and therefore pay less over time. Points can be a good choice for someone who knows they will keep the loan for a long time," they write.
Generally speaking, one discount point will lower your mortgage rate by .25%, although the exact discount each point is worth can vary from lender to lender. This means that a loan applicant who qualifies for a mortgage with a 4% interest rate could buy one point to lower their rate to 3.75% or two points to lower their rate to 3.5%.
Mortgage points are paid at closing when you sign all the paperwork for your home loan and get the keys to your property. Ultimately, this means that points increase your closing costs upfront.
If you decide to use mortgage points, you will see them listed on your loan estimate document, which you'll receive before your closing meeting.
How much do mortgage points cost?
The CFPB notes that, most of the time, each point you buy will cost you 1% of your loan amount. This means that buying one point to lower the rate on a $300,000 mortgage would cost you $3,000, and that buying one point on a $185,000 mortgage would cost you $1,850.
Meanwhile, buying two points on a $300,000 mortgage would cost you $6,000 and buying two points on a $185,000 mortgage would cost you $3,700.
Also be aware that points paid on an adjustable rate mortgage (ARM) work the same as points paid on a fixed-rate home loan. That said, the rate on your ARM will still adjust after a specific length of time (i.e. usually five or seven years) based on market conditions.
Pros and cons of mortgage points
The advantages and disadvantages of mortgage points depend on an array of factors that vary based on the homeowner. For example, mortgage points may be more or less valuable depending on the mortgage rate you're initially offered, the purchase price of the home, and how long you plan to live there.
With these factors in mind, here are some general pros and cons to be aware of.
Pros
- Buying points upfront can help you lower your mortgage interest rate for decades to come.
- Points can lower the cost of homeownership over the long run.
- Purchasing points upfront can help lower your monthly mortgage payment.
- If a lender won't approve you for the mortgage amount you need due to your income and debt-to-income ratio, buying points may lower your monthly payment enough to make you eligible.
Cons
- Mortgage points cost thousands of dollars, which you have to pay upfront to close on your home.
- You may need to stay in your home for years or even decades to recoup the cost of mortgage points paid upfront.
- Mortgage points tie up cash you could use for other purposes, such as buying furniture for your new home or paying for new landscaping.
Mortgage points: An example of savings
Generally speaking, buying points can be worth it if you plan to stay in your home for a long time. If you're buying your "forever home" and you opt for a 30-year home loan as a result, buying points could even save you tens of thousands of dollars in interest.
Consider the following example:
Let's say you're buying a home and putting down a large down payment, yet your mortgage amount will still be $300,000. If you qualified for a 30-year mortgage with an interest rate of 4.25%, your monthly payment (principal and interest) would work out to $1,476 and you would fork over $231,295.08 in interest charges over that time.
Now let's say you paid for points. Here's how much your payment could change, how your total interest charges would look, and how much you could save.
| Cost of Points | Monthly Payment (P&I) | Total Interest Charges | Long-Term Savings | Savings after Points | |
|---|---|---|---|---|---|
30-year loan at 4% | $3,000 | $1,432 | $215,608.52 | $15,686.56 | $12,686.56 |
30-year loan at 3.75% | $6,000 | $1,389 | $200,164.84 | $31,130.24 | $25,130.24 |
30-year loan at 3.5% | $9,000 | $1,347 | $184,968.26 | $46,326.82 | $37,326.82 |
When to Buy Mortgage Points (and When Not to)
For the most part, it can make sense to buy mortgage points if you plan to stay in your home for the long run. However, you can use a basic mortgage calculator with an amortization schedule to determine your break-even point.
In the example above, going from a 4.25% rate to a 4% rate saves you approximately $44 per month on your mortgage payment. With one point costing you $3,000 on this home loan, it would take you 68 months of payments, or five years and eight months, to start benefiting from the lower interest rate.
With that calculation in mind, it doesn't make any sense to buy mortgage points if you plan to stay in your home for less time than it would take for you to break even based on the cost of your points. Also note that mortgage points won't be as beneficial if you plan to make extra principal payments on your mortgage over time.
Finally, don't sacrifice the amount of your down payment in order to buy points. After all, a larger down payment can help you secure a lower interest rate regardless, as well as cheaper private mortgage insurance (PMI) or none at all.