While overall mortgage interest rates are set by the broader financial market, homebuyers taking out a mortgage can reduce the interest rate on their loan — at least a little bit — by buying mortgage points, also known as discount points.
Mortgage points are a percentage of the loan amount you pay at closing in exchange for your lender reducing the interest rate on your loan. While you’ll pay more in closing costs upfront, reducing your interest rate means your monthly mortgage payment will be less, and you can save a lot of money on interest over the life of your loan.
How Do Mortgage Points Work?
One mortgage point costs 1% of your loan amount. One point on a $500,000 loan would cost $5,000, 2 points would cost $10,000, and so on. You can purchase points in fractional amounts, usually down to one-eighth of a point.
Mortgage lenders are required to lower your interest rate with each point you buy. The exact reduction in your interest rate varies by lender, loan type, and market conditions. In general, you can expect an interest rate reduction of 0.25 percentage points for each mortgage point you buy.
If you do buy points, they will be listed on Page 2 of both your loan estimate and closing disclosure.
The break-even point
Your break-even point is how long it takes for the amount you save on your monthly mortgage payment from the reduced interest rate to exceed what you paid for points. If you move or refinance before the break-even point, you’ll lose money on buying points.
For example, buying 2 points on a $500,000 loan costs $10,000 and reduces your interest rate from 6% to 5.5%. That shrinks your monthly payment from $3,021 to $2,886, saving you $135 per month. To calculate your break-even point in months, divide the cost of points by the monthly savings:
10,000 ÷ 135 = 74.1
This means your break-even point is 75 months, so you’ll need to stay in the home for at least six years and three months for the interest rate reduction to begin saving you money.
Here’s a look at how much you could save on interest by buying points, and how long it will take to break even:
Savings With Mortgage Points on a $500,000 Home Loan
|Points||Interest Rate||Cost of Points||Monthly Payment||Monthly Savings||Total Interest||Total Savings||Break-Even Point|
Paying points vs. making a larger down payment
While buying points saves you money in the long term, it’s also possible to save money on interest by making a larger down payment. Putting more money down means you borrow less money, which reduces your monthly payments. You also don’t have to wait several years to break even, which means you can move homes or refinance your loan after only a few years without losing money on points.
“Making a larger down payment is another way to lower your monthly mortgage payments and potentially avoid paying mortgage insurance, but it does not have the same impact on the interest rate as buying points,” says Adie Kriegstein, a real estate agent and founder of the NYC Experience Team at Compass in New York. “In general, it’s a good idea to compare the costs and benefits of both options and consult with a mortgage professional to determine the best approach for your specific situation.”
For example, suppose you took out a 30-year fixed-rate loan for $500,000 at a 6% interest rate, and you have $5,000 set aside that you can either spend on points or a larger down payment. If you add the money to the down payment, then you’ll reduce your loan balance to $495,000, have a $2,967 monthly payment, and pay $573,399 in total interest.
Here’s look at some different outcomes from putting cash toward the down payment instead of points:
Effects of Loan Size on a 30-Year Fixed-Rate Mortgage for $500,000 at 6%
|Loan Amount||Monthly Payment||Monthly Savings||Total Interest||Total Savings|
Comparing this with the previous example, putting $5,000 toward points would save you $49 a month and $22,968 in interest compared to using the money for a larger down payment.
How To Shop For Mortgage Points
It’s important to shop around for your home loan and compare each lender’s offer before choosing a mortgage. Buying 1 point with one lender doesn’t necessarily get you a lower interest rate than buying no points with another lender.
One figure that can help you compare the different costs of each loan offer is the annual percentage rate. APR gives you the yearly cost of a loan, represented as a percentage rate. APR includes your interest rate plus other fees — like the cost of points. Paying attention to APR will help you directly compare the cost of each loan offer.
Can you negotiate points?
Discount points can be negotiable, but it’s going to depend on the lender or bank you’re working with. Some lenders may be willing to negotiate if you’ve gotten more competitive rates from other lenders. If you can submit proof, the lender may agree to match that price.
However, you typically can’t control how much your lender will reduce your interest rate, as this also can be tied to your credit score and financial history.
Pros and Cons of Buying Points on a Mortgage
There are benefits and drawbacks to consider when deciding if you should buy points on a mortgage.
“The pros of buying points include a lower interest rate, lower monthly mortgage payments, and potential savings on total interest paid over the life of the loan,” Kriegstein says. “The cons include the upfront cost, which can be significant, and the fact that the savings only materialize over time, so you need to be in the home for a long time to make it worth it.”
Advantages and Disadvantages of Buying Points
|Lower interest rate.||Higher closing costs.|
|Lower monthly payment.||It takes time to recoup the cost.|
|Less interest paid overall.||If you refinance or move before the break-even point, it won’t be worth it financially.|
|You could qualify for a larger loan.||It may be more effective to make a larger down payment.|
Here are answers to some frequently asked questions about mortgage points.