How to tell if mortgage points are worth the cost
Paying points to get a lower rate on a mortgage is almost always a losing proposition.
That's because most homeowners don't keep their mortgages long enough to do more than recoup the up-front cost of paying points.
A point is 1% of your loan amount. If you take out a $250,000 mortgage, 1 point equals $2,500.
In the mortgage world, there are two types of mortgage points:
- Origination points are a fee you must pay a bank or mortgage company to give you a loan.
- Discount points (the focus of this story) lower the interest rate on your loan and reduce your monthly payments.
Borrowers get a lower rate for paying discount mortgage points because they're prepaying a portion of the interest on their loan.
Indeed, discount points are tax-deductible, just like the interest you pay with each monthly mortgage payment.
How much can you lower your interest rate by paying points?
Anywhere from one-eighth to one-quarter of a percentage point per discount point.
A range like that makes it absolutely critical to compare offers that include points to those that don't and determine how much you're really saving by paying thousands of extra dollars up front.
Some banks and mortgage companies actually promote interest rates in their advertising that are only available by paying mortgage points. They hope you'll be so wowed by a rate that looks like it's lower than competitors are charging that you won't notice the additional up-front cost.
The key question you need to ask is: How long will it take me to recoup what I spend on points through lower monthly mortgage payments?
Considering two typical 30-year fixed-rate mortgages quickly shows how much paying a point will save (or cost) you on a typical $100,000 mortgage.
- Mortgage Option 1: 4% interest rate with no mortgage points
- Mortgage Option 2: 3.875% interest rate with 1 point
Paying Mortgage Points: The Tale of Two Loans
|Loan||Terms||Monthly Payment||Total Payments Over 30 Years|
|Loan 1||4%, No points||$477.42||$171,869.51|
|Loan 2||3.875%, 1 point||$467.38||$168,257.40|
|Savings from paying points||$10.04||$3,612.11|
If you pay 1 point, or $1,000, to get the 3.875% rate, you lower your monthly payments by right at $10 a month. (Our mortgage calculator will determine the monthly payment for any amount or interest rate.)
That means it would take 100 monthly payments, or more than eight years, to recoup the up-front cost of that point.
You won't really start saving any money until then — and therein lies the problem.
Chances are, you won't keep your loan much longer than that since the typical homeowner pays off a loan in just over eight years, according to data compiled by Bloomberg News.
Selling or refinancing before the break-even point means you'll actually wind up paying extra interest on the loan.
If you've just bought your dream home and know you'll keep your low-interest mortgage until your kindergartner graduates from high school, paying points may seem like a smart move.
With interest rates remaining historically low, chances are you won't need to refinance to reduce your rate.
But you might be forced to refinance or sell your home before you break even on your points if you face an unexpected life challenge like divorce, death of a spouse, disability or a job loss or transfer.
That's why Richard Bettencourt, a mortgage broker in Danvers, Massachusetts, and secretary of the Association of Mortgage Professionals, says paying mortgage points typically isn't a good financial move.
"The only way I see a point making sense is for that rarity of the person who says, 'I'm going to make all 360 payments (on a 30-year home loan) and never move,'" he said.
What about having a home seller pay points to buy down your rate? Isn't that a good deal for a buyer?
"Do you want the seller to reduce your monthly payment by $20 for the next 30 years or give you $7,500 to refinish the kitchen now?" Bettencourt asked.
Another way to look at mortgage points is to consider how much cash you can afford to pay at the loan-closing table, says Mark Palim, vice president of applied economic and housing research for Fannie Mae, a government-owned company that buys mortgage debt.
"If you use up some of your savings toward prepaying your interest, which makes your payment lower on a monthly basis, you have less savings if the water heater breaks," he pointed out. "Does it make sense to put more of your savings into the transaction to lower the monthly mortgage payments?"