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Buying mortgage points and lowering your mortgage's interest rate could be a good idea when you're buying a home or refinancing your mortgage. However, doing so will lead to higher closing costs. Figuring out when buying down the rate makes sense depends on the cost, your financial position and your short-term plans.
How Do Mortgage Points Work?
Mortgage points work differently depending on the type of mortgage point you're talking about:
- Origination points may be one of the closing costs you pay your mortgage lender. The points are a one-time fee, which is often based on a percentage of the total loan amount. You can try to negotiate origination points and compare lenders, as some may offer a loan with fewer (or no) origination points.
- Discount points are mortgage points that you purchase to get a lower interest rate on your loan. Each point costs 1% of the loan amount, and you pay the fee with your closing costs. Buying points can save you money overall because your monthly payment and interest costs will decrease.
As we go over mortgage points below, we'll be specifically addressing discount points. Origination points can be much easier to compare and understand—figuring out when to purchase discount points isn't as straightforward.
How to Calculate Mortgage Points
You'll want to figure out the break-even point when you're trying to decide if you should buy mortgage points. This is the point at which the upfront cost you pay to lower your interest rate is matched by the interest savings that result.
Generally, each point will cost 1% of the loan amount and will decrease the mortgage's interest rate by 0.25%. We'll use these amounts for the calculations made below, but know that some mortgage lenders may use a different price point or reduction amount.
Regardless of the cost and rate change, a straightforward way to find your break-even point is to divide the cost of the mortgage points by your monthly savings.
For example, if you get a $300,000 mortgage, each discount point costs $3,000. If buying a point on your 30-year mortgage means the interest rate changes from 4.5% to 4.25%, then your monthly payment decreases by about $44 (from around $1,520 to $1,476). Your break-even point is 3,000 divided by 44, which is about 68 months.
Purchasing more points could significantly decrease your monthly payment, although it might not change your break-even point much. Purchasing three points for $9,000 will decrease your monthly payment by $131 (from about $1,520 to $1,476). However, the break-even point only increases by one month.
Other factors can also impact your break-even point. For example, you may be able to finance the discount point purchase, but doing so could extend your break-even point due to interest. Additionally, if you purchase points with an adjustable-rate mortgage, the lower interest rate might only apply to the initial fixed-rate period.
Purchasing points is essentially prepaying interest, which means it may be a tax-deductible expense. If you meet the IRS' requirements, you may be able to take the full deduction in the first year. Otherwise, the deduction will be spread out over the lifetime of the loan. In either case, whether this alters your calculations depends on your overall financial and tax situation.
Scenarios Where Buying Mortgage Points May Make Sense
Understanding how much points cost, the impact on your monthly payments and your break-even point is a good place to start. From there, you can consider your specific situation to determine if buying points is a smart idea.
Generally, buying mortgage points could make sense when:
- You plan on living in the home beyond the break-even point.
- You likely won't benefit from refinancing your mortgage before the break-even point.
- Buying points won't strain your finances.
However, if you need the cash for other expenses—such as moving, remodeling or monthly bills—you want to make sure buying points won't leave you in a bind. Additionally, if you plan on selling the home soon, or you think you might refinance, the savings from buying a lower interest rate will be limited.
In fact, if you suspect you might not stick with the same mortgage for long, it could make more sense to ask for lender credits rather than buying mortgage points. Lender credits could basically be seen as selling points rather than buying them, because the lender pays you to accept a higher interest rate. It can make sense if you're having trouble affording a down payment or the closing costs. Or if you suspect you may move or refinance soon.
How to Buy Mortgage Points
You can buy mortgage points by making an arrangement with your lender before the loan closes. The fee for the points will be paid directly to the lender as part of your closing costs.
When you receive the Loan Estimate document for your mortgage, you'll see the mortgage points separated as a line-item cost on the top left of page two. If your Loan Estimate shows that you're paying points and you didn't expect or want to, ask your lender about other options. They may be able to offer you a mortgage without points, but expect a higher interest rate in exchange.
Additional Ways to Lower Interest Rates or Costs on Your Loan
Buying mortgage points isn't the only way to lower your mortgage's interest rate or how much you pay in interest overall. Here are some additional options you'll want to look into:
- Shop lenders and loan types. It can pay to get offers from multiple mortgage lenders, as each lender may have its own method for determining the interest rate it will offer you. Additionally, your rate could depend on the type of mortgage you get and whether it has a fixed or adjustable rate. Shop around to see which ones you'll qualify for and which will be best.
- Increase your down payment. While you'll need to come up with extra cash for a large down payment, doing so could lead to a smaller loan amount and lower interest rate. Putting at least 20% down can also help you avoid paying for mortgage insurance, which can lower your monthly payment.
- Decrease the loan's term. If you can't afford a higher upfront cost but could take on a larger monthly payment, a shorter repayment term can lead to a lower interest rate.
- Find a less expensive home. Buying a cheaper house is another way to reduce your monthly payment and down payment amount.
Once you have a mortgage, you may be able to refinance to get a lower interest rate. Or, if your lender allows it, you could make bimonthly payments to decrease how much interest accrues overall.
Improve Your Credit to Save Money
Your credit scores can greatly affect your ability to get a mortgage and the interest rate you'll receive on a new loan or when refinancing. You can check one of your credit scores, a FICO® Score☉ 8, for free from Experian.
However, mortgage lenders will likely use different FICO® Scores to evaluate your application. With Experian CreditWorks℠ Premium, which charges a monthly fee, you can also view the FICO® Score 2 score based on your Experian credit file as well as the factors affecting it. You can then start using this information to improve your credit scores and get your credit ready for a mortgage.