Is It Better to Buy Down Points on a Mortgage?

Paying an upfront fee to reduce your mortgage interest rate, known as “buying down the rate” or “points,” is a common question for homeowners. While it promises lower monthly payments and reduced interest costs, the financial benefit is not always straightforward. Evaluating this choice requires understanding mortgage points and careful analysis.

Understanding Mortgage Points

Mortgage points are fees paid to a lender for a reduced interest rate. They are typically one percent of the total loan amount. For example, one point on a $300,000 mortgage costs $3,000.

Mortgage points include discount points and origination points. Discount points “buy down” the interest rate, directly lowering the loan’s rate. Origination points are lender fees for processing and underwriting, and do not reduce the interest rate. The focus for rate reduction is on discount points.

Paying discount points upfront can lead to a lower interest rate for the life of a fixed-rate mortgage. Lenders vary on how much a point reduces the rate, but a common reduction is 0.25 percentage points per point. These costs are usually paid at closing, becoming part of total closing expenses.

Calculating the Break-Even Point

Calculating the break-even point determines the value of buying down points. This calculation reveals how long monthly savings from a lower interest rate will take to offset the initial cost. Understanding this timeline helps make an informed financial decision.

To calculate the break-even point, determine the difference in monthly mortgage payments with and without points. This difference represents monthly savings. Divide the total cost of points by this amount. The result is the number of months to recoup the initial investment.

For example, on a $300,000, 30-year fixed-rate mortgage, a 7.0% rate results in a $1,996 monthly payment. If one point ($3,000) reduces the rate to 6.75%, the new payment might be $1,946. This creates a $50 monthly savings. Dividing the $3,000 cost by the $50 savings yields a 60-month, or five-year, break-even period.

This calculation highlights that if a borrower remains in the home or keeps the mortgage beyond the break-even period, they will realize net savings. If the home is sold or the mortgage is refinanced before this point, the initial investment in points will not be fully recovered. Compare the break-even period with your expected duration of staying in the home or holding the mortgage.

Key Considerations Beyond the Math

While the break-even calculation provides a clear financial timeline, other factors influence whether buying down points is right. These considerations encompass personal financial situations and future plans.

A key factor is the borrower’s time horizon for remaining in the home. If you expect to sell or refinance within a few years, especially before the break-even point, the upfront cost of points may not be recouped. For those planning to stay for an extended period (ten years or more), long-term interest savings often make paying points beneficial.

Another consideration is the opportunity cost of funds used for points. This capital could be allocated elsewhere, such as a larger down payment, an emergency savings fund, or paying down other high-interest debts. Evaluate if potential interest savings from points outweigh these alternative uses of capital.

The prevailing interest rate environment also plays a role. In high interest rate periods, buying down the rate might seem appealing for a more manageable monthly payment. If rates are expected to decline soon, consider if refinancing later could offer better terms without the initial outlay for points.

Finally, a borrower’s personal cash flow and financial priorities are important. Some prioritize lower monthly mortgage payments to ease their budget, even with a larger upfront expense. Others prefer to retain more cash at closing, even with slightly higher monthly payments. This balances immediate liquidity against long-term interest savings.

Discount points may be tax-deductible as prepaid interest in certain circumstances. For a primary residence, points paid directly by the borrower can often be deducted in the year paid, provided specific IRS criteria are met (e.g., clearly designated on the settlement statement and customary). Points paid for a second home or for refinancing generally must be deducted over the life of the loan. Consult a tax professional and refer to IRS Publication 936 for guidance on deductibility.