Mortgage points can help buyers lower their interest rate, but they are not automatically a good deal.
A mortgage point, often called a discount point, is an upfront fee paid at closing in exchange for a lower mortgage rate. The basic tradeoff is simple: pay more now to reduce the monthly payment later. The hard part is deciding whether the upfront cost is worth it.
The Consumer Financial Protection Bureau says points lower the interest rate in exchange for paying more at closing, while lender credits do the opposite: they reduce upfront closing costs in exchange for a higher interest rate.
Key takeaways
- Mortgage points are upfront fees paid to lower the interest rate.
- One discount point equals 1% of the loan amount, according to Freddie Mac.
- The rate reduction from one point is not fixed.
- Points usually make more sense for buyers who plan to keep the loan long enough to reach the break-even point.
- Lender credits work in the opposite direction by lowering closing costs but raising the rate.
- Buyers should compare multiple loan options before paying points.
What are mortgage points?
Mortgage points are a way to buy down the mortgage rate.
Freddie Mac explains that one discount point equals 1% of the loan amount. On a $400,000 mortgage, one point would cost $4,000. On a $300,000 mortgage, one point would cost $3,000.
But one point does not always reduce the rate by the same amount. The CFPB notes that discount points have no fixed value in terms of the interest-rate change. The actual reduction depends on the lender, loan type, market conditions and borrower profile.
That is why buyers should not ask only, “How many points?” They should ask, “How much does this lower my payment, and how long will it take to recover the upfront cost?”
How the break-even math works
The break-even point is the number of months it takes for the monthly savings to equal the upfront cost.
For example:
| Example | Amount |
|---|---|
| Loan amount | $400,000 |
| One point | $4,000 |
| Monthly savings from lower rate | $100 |
| Break-even point | 40 months |
In that example, the buyer would need to keep the loan for more than 40 months for the points to start producing net savings.
If the buyer sells, refinances or pays off the loan before reaching the break-even point, the points may not pay off.
When points may make sense
Mortgage points may make sense when the buyer has enough cash after closing, monthly savings are meaningful, the buyer plans to keep the home and loan for several years, the break-even period is reasonable and the buyer is not draining emergency reserves to pay the points.
Points may be especially worth comparing when rates are high and the buyer expects to keep the loan long term.
But buyers should be cautious. Paying more points may not be worth it depending on the loan and timing.
When points may not make sense
Points may not make sense when the buyer expects to sell soon, may refinance quickly, has a break-even period that is too long, would weaken emergency savings by paying points, needs cash for repairs or moving costs, or would benefit more from lender credits.
A buyer who is already short on cash may be better off preserving savings than paying thousands upfront for a modest monthly reduction.
Points vs. lender credits
Points and lender credits are opposite tools.
Points increase upfront cost and reduce the rate. Lender credits reduce upfront cost and increase the rate. The CFPB describes this as a tradeoff in how borrowers pay for mortgages and closing costs.
A buyer with plenty of cash and a long time horizon may prefer points. A buyer who needs cash to close may prefer lender credits. Neither is automatically better.
What this means
Mortgage points are a math decision, not a sales feature.
Before paying points, buyers should ask the lender for side-by-side loan estimates showing the rate, points, monthly payment, APR, cash to close and total interest over the expected ownership period.
FAQ
What are mortgage points?
Mortgage points are upfront fees paid at closing to reduce the mortgage interest rate.
How much is one mortgage point?
Freddie Mac says one discount point equals 1% of the loan amount.
Do mortgage points always save money?
No. Points only save money if the buyer keeps the loan long enough for the monthly savings to exceed the upfront cost.
What is the break-even point on mortgage points?
The break-even point is the upfront cost divided by monthly savings. If points cost $4,000 and save $100 per month, the break-even point is 40 months.
Are lender credits the opposite of points?
Yes. Lender credits reduce closing costs upfront in exchange for a higher interest rate.
Sources
- CFPB Lender Credits and Discount Points
- CFPB Trends in Discount Points
- Freddie Mac Discount Points
- Freddie Mac Discount Points Research