What Are Mortgage Points? An Easy-To-Understand Guide

Many future homebuyers wonder, "What are mortgage points?" Find out how mortgage points work and how to use them to lower your monthly payment.

Buying a home is a big commitment and one of the largest purchases one can make. While it’s common for buyers to negotiate a sales price and shop for the best rate to maximize savings, we often don’t hear about using mortgage points to essentially “buy down the rate.”

If you’re preparing to purchase or refinance a home, use this guide to determine whether this option makes sense for you. In this guide, you’ll also learn how mortgage points can be used with adjustable-rate mortgages to reduce the initial interest rate. Lastly, you’ll discover how buying mortgage points can make your mortgage payment even more affordable when market interest rates are low.

What Are Mortgage Points?

Mortgage points, also commonly known as discount points, allow borrowers to pay a fee to reduce their interest rate and thus lower their monthly payment and overall cost of the loan.

One point typically costs about 1% of the mortgage (or $1,000 per $100,000); each point purchased generally reduces a fixed rate by 0.25%, but the terms vary by lender. For example, on a $200,000 loan, one mortgage point may cost $2,000.

How Much Can You Save?

Your overall savings will depend largely on how long you plan to stay in the home. Generally, the longer you stay, the more you save. The break-even point is generally considered the time it will take for your monthly savings to equal the cost of the mortgage points.

To estimate cost savings, use our mortgage loan calculator to compare how different interest rates affect the projected monthly payment and total cost of a mortgage.

In the example* below, we illustrate the impact of discount points on a 30-year mortgage.

*Figures are illustrative and for educational purposes only. Discount point fees and terms vary. †This is the cost of principal and interest only; taxes, insurance, and other costs are not included.

Home Interest Rates

Understanding mortgage options and how home interest rates work is important when deciding whether to buy mortgage points. The two main types of mortgages are fixed-rate and adjustable-rate mortgages (ARMs).

Fixed-Rate Mortgages

A fixed-rate mortgage is a home loan in which the interest rate remains the same for the life of the loan. Some homebuyers choose this option because it provides consistent monthly mortgage payments with no surprises.

However, fixed-rate mortgages often start with higher interest rates than adjustable-rate mortgages and may lead to paying more interest in the long term. Many homeowners use mortgage points with fixed-rate mortgages when they expect to stay in the home long-term and have the funds ready for the down payment and the mortgage point payment.

Adjustable-Rate Mortgages

Adjustable-rate mortgages (ARM) are a popular type of home loan with an interest rate that changes over time. The initial rate of an ARM is usually lower than a fixed-rate mortgage, where the home loan has a consistent interest rate for the life of the loan.

With ARMs, your interest rate stays the same for a set period and then adjusts at regular intervals, typically every six or 12 months. Many borrowers choose this option to take advantage of the ARM’s lower initial interest rate. If you plan to sell or refinance during the loan period, you may also benefit since you won’t experience any rate adjustments. This option can be attractive to first-time homebuyers.

Can You Use Mortgage Points On An Adjustable-Rate Mortgage (ARM)?

Yes, however, the discount will only apply to the initial fixed-rate period. On a 5/5 ARM, for example, the discount would remain in effect for five years. One point typically reduces the interest rate by 0.375%, but the terms vary by lender.

When you buy mortgage points with an ARM, you pay upfront to reduce the interest rate during the mortgage’s fixed-rate period. Using mortgage points can help with monthly savings by making your mortgage payments more affordable during the start of the mortgage.

Is It Worth It?

It’s best to make a more informed decision by calculating the break-even period, or the time it would take to recoup the fees associated with purchasing the points. Do this by dividing the cost of the points by the amount you’d save on your monthly payments.

Let’s use the figures above for our calculation. Begin by dividing the cost of the points, $5,000, by what you’d save on the monthly payment, $70.93 ($1,193.54 – $1,122.61). It would take 71 months, nearly 6 years, to save as much as you paid.

If you don’t intend to stay in the home for at least that long, purchasing mortgage points wouldn’t make sense for you.

Buying Mortgage Points

Mortgage points are paid at closing along with the down payment, closing costs, reserves, etc. These costs are listed in the Loan Estimate provided after applying for the loan and the Closing Disclosure provided before closing.

Buying a home requires a large sum of money upfront; borrowers will have to determine whether purchasing mortgage points is feasible.

What Else Should I Consider?

If you have enough saved for a down payment and mortgage points, put some estimates together. For example, compare how applying extra funds to the down payment, not discount points, affects projected costs. This may be a more favorable option if it helps you avoid private mortgage insurance (PMI) and reduces your interest rate.

Another item to consider is the rate environment. Buying mortgage points in a low-interest-rate environment could mean locking in the best rate possible. Conversely, it may be better to hold off on purchasing points if you plan to refinance due to a high interest rate environment.

Finally, mortgage points are prepaid interest and may be tax deductible if you itemize deductions. The home must be your primary residence and other requirements must be met. Here’s additional guidance from the Internal Revenue Service.

Summary

Purchasing mortgage points can help lower your monthly mortgage payments by paying an upfront fee at the time of purchase. It’s important to consider how long you plan to stay in a home when considering whether buying mortgage points will benefit you.

A+FCU Can Help You Understand Mortgage Options

At A+FCU, we are passionate about helping future homebuyers understand all of their options. whether you’re considering a fixed-rate or adjustable-rate mortgage or purchasing mortgage points to lower your monthly payments, we can help.

Want to learn more? Our first-time homebuyer webinar and free homeownership counseling can help you understand the homebuying process. With a variety of home lending options, tools, and guides, we have everything you need to become an informed homebuyer.

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