How Much Is 1 Point on a Mortgage?

Mortgage points are an upfront cost that can influence the overall expense of borrowing a home loan. Understanding what these points are, how their cost is determined, and their implications is important for anyone navigating the home financing process. This article clarifies mortgage points, detailing their calculation, distinguishing between different types, and offering insights into their financial impact.

Understanding Mortgage Points

A mortgage point is a fee paid directly to the lender at closing. One “point” is equivalent to one percent of the total loan amount. This upfront payment can reduce the interest rate over the loan’s lifetime or cover administrative costs associated with processing the mortgage. Points are an integral part of the closing costs a borrower pays when finalizing a home loan.

These points are prepaid charges added to the overall closing costs. Paying points means providing a lump sum payment at the outset of the loan agreement.

Calculating the Dollar Value of a Point

Calculating the dollar value of a mortgage point is straightforward, as each point represents one percent of the loan amount. To determine the cost of one point, multiply the total loan amount by 0.01. This translates the percentage into a dollar figure due at closing.

For instance, on a $200,000 mortgage loan, one point costs $2,000. For a $350,000 loan, one point amounts to $3,500. For a $500,000 loan, a single point costs $5,000. The dollar cost of points increases proportionally with the size of the mortgage.

Distinguishing Discount Points and Origination Points

While both are referred to as “points,” discount points and origination points serve distinct financial purposes within a mortgage transaction. Discount points, also known as “buy-down points,” are paid by the borrower to reduce the interest rate on the mortgage loan. This payment acts as prepaid interest, resulting in lower monthly mortgage payments over the life of the loan. Each discount point typically lowers the interest rate by approximately 0.125% to 0.25%, though the exact reduction can vary by lender and market conditions.

Origination points are fees charged by the lender to cover the administrative costs of processing and evaluating the loan application. These points compensate the lender for services such as underwriting, preparing loan documents, and other overhead expenses involved in loan origination. Unlike discount points, origination points do not reduce the interest rate of the loan; they are simply a fee for the service of acquiring the mortgage.

The tax treatment of these points varies. Discount points paid on a mortgage for a primary residence may be tax-deductible as prepaid interest, often in the year they are paid, under specific Internal Revenue Service (IRS) guidelines. Origination points, however, are generally not tax-deductible. Borrowers should consult IRS Publication 936 for rules regarding the deductibility of points.

Evaluating the Value of Paying Points

Deciding whether to pay discount points involves a financial analysis, primarily centered on the concept of a “break-even point.” This point represents the duration it takes for the savings from a lower interest rate to offset the upfront cost of the points. The break-even point is calculated by dividing the total cost of the points by the amount saved on the monthly mortgage payment due to the reduced interest rate.

For example, if paying $3,000 for discount points reduces your monthly payment by $50, your break-even point would be 60 months ($3,000 / $50 = 60 months), or five years. If you plan to remain in the home and keep the mortgage for a period longer than the break-even point, paying points could result in overall savings. If you anticipate selling the home or refinancing the mortgage before reaching the break-even point, paying points may not be financially advantageous.

Several factors influence this decision, including how long you expect to stay in the home, the current interest rate environment, and your financial liquidity. Discount points can be tax-deductible as home mortgage interest, but this benefit is only realized if you itemize deductions on your federal income tax return. The IRS provides specific criteria for deducting points, including requirements that the loan be secured by your main home and that paying points is an established business practice in your area.