How Much Are Points on a Mortgage?

Mortgage points are fees paid to a lender during the home loan process. These fees can either reduce the interest rate on a mortgage or cover the costs associated with processing the loan. Understanding these upfront costs and their long-term effects is important for securing a mortgage. The decision to pay points involves considering both immediate financial outlay and potential savings over the life of the loan.

Understanding Mortgage Points

Mortgage points are fees borrowers pay to lenders, expressed as a percentage of the total loan amount. These points come in two forms: discount points and origination points. Each type serves a distinct purpose within the mortgage transaction.

Discount points are prepaid interest borrowers pay upfront to secure a lower interest rate on their mortgage. One discount point typically costs 1% of the loan amount. For example, paying one discount point might reduce the interest rate by approximately 0.25% for the life of the loan. This strategy is often referred to as “buying down the rate.”

Conversely, origination points are fees charged by the lender for processing the loan application, underwriting, and other administrative tasks. Unlike discount points, origination points do not reduce the interest rate of the loan. These fees are typically part of the closing costs.

Calculating the Cost of Mortgage Points

The cost of mortgage points directly relates to the loan amount. For instance, on a $200,000 loan, one point would cost $2,000, while two points would amount to $4,000.

Lenders may also offer fractional points, such as 0.5 or 0.75 points. In such cases, the cost is calculated proportionally; for example, 0.5 points on a $200,000 loan would be $1,000. These costs are paid at closing and are listed on the loan estimate and closing disclosure documents.

The Impact of Mortgage Points on Your Loan

Paying discount points reduces the interest rate on a mortgage. Each discount point purchased can lower the interest rate by about 0.25%, though the exact reduction can vary by lender and market conditions. For example, if a borrower pays one point, a 6.5% interest rate might decrease to 6.25%.

A lower interest rate translates to reduced monthly mortgage payments. On a $200,000, 30-year fixed-rate mortgage, a reduction from 6.5% to 6.25% could lower the monthly principal and interest payment by several dollars. This smaller monthly obligation can make homeownership more financially manageable.

Over the entire loan term, the cumulative effect of a lower interest rate can result in long-term interest savings. For a 30-year mortgage, even a small reduction in the interest rate can save thousands of dollars in total interest paid. While the upfront cost of points increases closing expenses, the long-term savings can outweigh this initial outlay, especially for borrowers who plan to keep the mortgage for many years.

Financial Considerations for Mortgage Points

Deciding whether to pay for mortgage points involves a financial analysis. The “breakeven point” is the duration it takes for monthly savings from a lower interest rate to offset the initial cost of the points. This is calculated by dividing the total cost of the points by the monthly savings. For instance, if paying $3,000 for points saves $50 per month, the breakeven point would be 60 months, or five years. If a borrower plans to stay in the home longer than this breakeven period, paying points can be financially advantageous.

Discount points paid for a mortgage used to buy or build a primary residence may be tax-deductible. This deduction can often be taken in the year the points are paid, provided certain conditions are met (e.g., the loan is secured by the main home, and point payment is an established business practice in the area). If these criteria are not met, or for refinanced mortgages, the deduction may need to be amortized over the life of the loan. Borrowers should consult a tax professional for guidance, as tax laws are complex and individual circumstances vary.

Points are typically paid as an upfront cash payment at closing. In some situations, lenders may offer the option to roll the cost of the points into the loan amount. While this avoids an immediate out-of-pocket expense, it increases the total principal borrowed, leading to higher overall interest paid. Evaluating the payment method should align with a borrower’s immediate cash availability and long-term financial strategy.