What Are Mortgage Points and Do You Need to Buy Them?

Purchasing mortgage points could be a good way to reduce your monthly home payments beyond just using a strong down payment. Maybe you’ve heard of points as you’re shopping around for a home. But you may not be sure what they are or how they’re used. We’re here to fill in the gaps for you.

Take a moment to find out if this is a street you want to go down while finding a new neighborhood to call your own.

What Are Mortgage Points?

Mortgage points are essentially fees that borrowers pay directly to lenders at the time of closing. You can purchase mortgage points to buy down your interest rate. This lowers your monthly payment throughout the life of your loan.

One fee point costs one percent of the total loan amount. So if you’re borrowing $100,000 for your mortgage, one point costs $1,000. If your mortgage is $200,000, one point is $2,000.

How much will a point actually reduce your interest rate? It varies from one lender to the next. But since mortgage points are really just prepaid interest, they are almost always tax deductible if you itemize on Form 1040 Schedule A.

Learn More: What is the Schedule A?

How Many Mortgage Points Can You Purchase?

Most lenders cap the number of mortgage points you can purchase at four. But some won’t allow you to purchase more than three points.

Each point you purchase lowers your interest rate by a certain amount. As mentioned, though, the actual amount of interest rate reduction that each point will earn varies from lender to lender.

Your lender should tell you when you apply for a mortgage how much paying points can reduce your interest rate. It’s worth comparing between lenders. Paying the same amount of money up front to one lender may reduce your interest rate by a lot more than with another lender.

Do Mortgage Points Work?

You might be wondering if you’ll come out ahead if you put the money for mortgage points down at closing if you want to reduce your monthly payments.

There are actually a number of market conditions and personal circumstances at play here. So is it worth your while to hand over potentially several thousand dollars to your lender on closing day? The answer is it depends.

The fact that mortgage rates are still historically low right now certainly reduces the urgency when it comes to trying to bring down your interest rate.

Learn More About Closing Costs

The main thing to determine when deciding whether or not to purchase mortgage points is how long it will take you to break even. You can figure out how many months it will take you to reach this point by dividing the cost to purchase points by the amount of money you’ll save on interest payments per month. Calculators like this one can help you figure it out.

Ideally, you’ll want to be in the home past your break-even point. So if you break-even point is five years, you’ll only want to purchase points if you plan to stay in the home for at least six years. Typically, you’ll break even on points somewhere around the five year mark, just as a ballpark guess.

Another consideration is if you’re planning to make improvements on the home after you move in. Having cash on hand to make some updates and improvements could be important. It can be difficult to cover not only the down payment, but also the closing costs and mortgage points. That money has to come from somewhere. And completely training your cash reserves to cover your down payment and mortgage points could leave you in a frustrating position.

Should You Buy Mortgage Points?

Buying mortgage points could be a great financial decision if you’ve found a home that you plan to stay in for a long time. However, it’s probably not a smart idea to drain too much out of your savings just to shave a few dollars off of your monthly payments, especially if you’re likely to move again within a few years.

It’s worth having your lender run the numbers for purchasing mortgage points if you plan to stay in your home for a long time. The big question that you to ask is how many years you will need to stay to make purchasing mortgage points a smart decision.

You should also consider what you’ll give up to buy mortgage points. Will you have to reduce your down payment? That could backfire. If your down payment drops below 20%, you’ll likely get stuck with paying private mortgage insurance each month. This could easily negate your purchased-points savings — and then some!

Related: What Kind of Mortgage Does Your Credit Score Qualify For?

The bottom line is that you’ll want to put a lot of thought into whether or not to purchase mortgage points. If you plan to be in the home long enough to break even or save money, they’re a good option. If you have enough money to cover the down payment, closing costs, and mortgage points — without draining your emergency savings — it may work in your favor.

First, though, try to negotiate the asking price down as much as possible. Search for the right lender and interest rate, until you find the best option available. Both of these are free ways to reduce your monthly payment.

Topics: Mortgages

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