How much do points reduce interest rate

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It’s a sellers market and homebuyers have it rough. 

Mortgage rates are rising, home prices continue to break records, supply of homes haven’t caught up with demand, and the competition is still strong.

In order to find savings in today’s market, scoring a lower mortgage rate is one of them. A few ways to do this is to earn a high credit score, save for a large down payment, and compare multiple offers from lenders.

But there’s another way to get a lower interest rate—for a price. 

Purchasing mortgage points, also known as “buying down the rate,” is a strategy that involves paying additional money upfront at closing in order to shave down the interest rate of your loan. 

Generally, buying mortgage points is only worth your while if you plan to stay in your home for several years, usually at least six. Beyond that, it’s a matter of balancing priorities. Would you rather spend that money upfront to buy down your rate, or does it make more sense to put down a larger down payment—or even sock that money away into your 401(k) account? 

Here are the things to consider when evaluating mortgage points.

What Are Mortgage Points or Discount Points?

Lenders offer mortgage points, also known as discount points, when you apply for a mortgage. Mortgage points are paid to the lender at your closing in exchange for a lower interest rate. Lenders also refer to mortgage points as “buying down the rate.” 

Choosing to take points on a mortgage is completely optional, but it is one way to lower your overall interest rate and your monthly payment. Most lenders let you purchase between one and three points (sometimes less, sometimes more) which you pay upfront as part of your closing costs. One point equals 1% of your mortgage, or $1,000 for every $100,000. The monthly savings that result will depend on the interest rate, how much you borrow, and the term of the loan.

The length of time you plan to be in the home is crucial to your calculations. It typically takes a borrower between 4-6 years to recoup the cost from paying discount points at closing, says David Reischer, a real estate attorney at LegalAdvice.com, an online legal consultation tool.

Keep in mind mortgage points are usually only used for fixed-rate loans. They are available for adjustable-rate mortgages (ARMs), but they only lower your rate for your introductory period until the rate adjusts, which does not make the investment worth it. 

What Are Mortgage Origination Points?

Mortgage origination points are fees you pay to a lender for the processing of your home loan. These fees are how loan originators get paid. 

Each point is 1% of the total loan amount. One point on a $200,000 loan would be a $2,000 charge. Because a single point has a higher total dollar value for a larger loan, you are likely to have more success negotiating smaller origination fees (as a percentage of the loan balance) if you have a larger mortgage balance.

How Mortgage Points Affect Your Loan

The table below will show you just how much points cost, how much you can save, the discount you could see on your rate, and how long it takes to break even using the example of a 30-year, 5.5% rate, and $350,000 loan. 

Will You Break Even?

30-Year Fixed, $350,000 Loan

As you can see, investing $7,000 upfront to buy down two points will reduce your rate from 5.5% to 5%, saving you $108 on monthly mortgage payments. Once your $7,000 is paid back after about 5.5 years, you will start to see savings. In this example, a savings of $108 per month can turn into $1,296 saved per year and $13,655 over ten years.

To make mortgage or discount points worth it, you’ll need the discipline to actually put away the $108 you saved each month and you don’t want to move or refinance before the breakeven period is up. 

Pro Tip

Run the numbers to see how much mortgage points could save you—and whether that money would be better spent (or invested) elsewhere.

Are Discount Points Worth it? 

“Generally, buying mortgage points is the most beneficial when you can comfortably afford them and plan to stay in your home for a long period of time,” says Baruch Silvermann, CEO and founder of The Smart Investor, an online investment education site. 

Finally, note that buying a home means setting yourself up for the bevy of expenses that come with owning a property, from taxes to repairs. You’ll need to have enough cash to make a down payment, cover closing costs (which can equal 2 to 5% of your purchase price) and have enough savings leftover to get you through any emergencies or loss of income. If purchasing points leaves you without sufficient savings, it may be a risky proposition. 

Before you decide, compare your options with other investment opportunities. We find investing in your retirement and 401(k) can see the best rewards. The compound interest on $5,000 does not come with any strings attached compared to buying points. Meaning, it’s not dependent on whether or not you move, refinance, or have the discipline to save the $108 difference each month. It is a set-it-and-forget-it approach. 

To decide for yourself if mortgage points are worth it, ask yourself if you can afford the cost of and all other closing costs. Determine if you’re planning to be in your home long enough to recoup the cost of mortgage points. Only then will you feel confident to decide if discount points are worth it. 

Can You Negotiate Points on a Mortgage?

Discount points are an entirely optional fee for your mortgage and you should be aware of any points you are paying. Some lenders will advertise exceptionally low mortgage interest rates, only to have a substantial amount of discount fees built into that price.

It’s a good practice to review your Loan Estimate to confirm what fees you are paying. Discount points will be listed under the origination charges on page 2 in box A.

Are Mortgage Points Tax Deductible?

Mortgage points may be tax-deductible as mortgage interest on your primary residence if you meet the IRS requirements. First off, you’ll need to itemize your taxes, which is less common since the standard deduction was increased for 2022. Unless all of your deductions are greater than the standard deduction, you won’t have any tax savings from paying discount points.

As with anything related to your taxes, it’s a good idea to consult with a tax advisor to ensure that you are taking advantage of every deduction available to you and properly documenting everything.

Frequently Asked Questions: FAQ

How much is 1 point worth in a mortgage?

One mortgage point equals 1% of the total loan amount and lowers the interest rate by 0.25%. For example,— for example, on a $300,000 loan, one point would be $3,000. And if the original rate was 5.5%, it would be lowered to 5.25% with one point. 

Should I pay discount points to get a lower rate?

That depends. Paying for discount points to get a lower interest rate could be a good financial strategy if you plan to live in the home long enough to cover the breakeven period. The upfront costs need to bake out before the savings can kick in. If you move or refinance before that period is up, they are worthless.  

This article was updated on Sept. 4, 2020, to remove comments made by a source whose credentials do not meet NextAdvisor editorial standards.