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What Are Mortgage Points?

A mortgage point – sometimes called a discount point – is a one-time fee you pay to lower the interest rate on your home purchase or refinance. One discount point costs 1% of your total home loan amount. For example, if you take out a mortgage for $100,000, one point will cost $1,000. When you purchase a point, you prepay the interest for a smaller monthly payment.

Mortgage Discount Points Vs. Mortgage Origination Points

You may have heard the term “mortgage origination points” before. It refers to the origination fees you pay your lender to cover the cost of processing and reviewing your mortgage loan application. Depending on your credit score and the size of your down payment, sometimes you can negotiate these fees with your loan officer.

Unlike discount points, mortgage origination points don’t lower your interest rate. And origination points aren’t optional. You must pay this one-time upfront fee at closing.

How Do Mortgage Points Work?

Each discount point you buy reduces your interest rate by a set percentage point. The discount varies by lender, but you can generally expect a 0.25% interest rate reduction for each point purchased, though most mortgage lenders cap the number of points you can buy. You can also purchase points in increments of eighths of a percent, or 0.125%.

Points are paid at closing. Your lender will calculate the cost of any points you purchased and add them to your other closing costs.

Let’s run through an example. Let’s say you take out a 30-year fixed-rate mortgage for $200,000 with a 5.125% interest rate. Your lender offers you an interest rate of 4.75% if you purchase 1.75 mortgage points. On a $200,000 loan, each point will cost $2,000. For your loan, 1.75 points will cost $3,500. If you don’t buy the mortgage points, your interest rate will stay at 5.125%.

Over 30 years, if you don’t pay down the loan early, the cost of the loan with interest is $391,809. If you buy the 1.75 points, you will pay $375,586 over the life of the loan. With mortgage points, you’d save $16,223 over your 30-year mortgage.

Discount points work similarly for adjustable-rate mortgage (ARM) loans as they do with fixed-rate loans. The only difference is that the interest on your ARM will adjust after 5 or 7 years, making it crucial to know how long it will take to make buying points on a mortgage worth the investment. 

Benefits and drawbacks of mortgage points

Mortgage points, or discount points, offer both benefits and drawbacks that you need to consider before deciding to purchase them. Here’s a closer look at the pros and cons of mortgage points:

Pros of mortgage points

Lower i nterest rates: By purchasing mortgage points, you’re lowering the interest rate on your mortgage, which leads to reduced monthly payments and less total interest over the loan term.

Tax deductions: The IRS allows homeowners to deduct the cost of mortgage points from their annual tax returns, which can lead to significant savings.

Cons of mortgage points

Upfront cost:  Mortgage points require an upfront payment at closing. This increases the initial cost of your mortgage.

Might not always save you money: The benefits of mortgage points only kick in after the savings from the lower interest rate surpass the cost of the points - known as the breakeven point. If you sell or refinance your home before this point, you won’t realize the financial benefit of the points.