Is It Worth Buying Points on a Mortgage?

When securing a mortgage, borrowers often encounter the option of paying “points,” which are upfront fees paid to the lender. These fees can effectively reduce the interest rate on the loan, potentially lowering monthly payments over the mortgage’s lifetime. Deciding whether to pay these points involves a careful evaluation of the immediate costs against the long-term financial benefits.

Understanding Mortgage Points

Mortgage points represent fees paid directly to a lender at the time of closing to either cover loan processing costs or reduce the interest rate. There are two primary types: origination points and discount points. Origination points are fees charged by the lender for processing the loan, and they are typically not tax-deductible.

Discount points are specifically paid to lower the interest rate on the mortgage, often referred to as “buying down the rate.” Each point typically costs 1% of the total loan amount. For example, on a $300,000 mortgage, one point would cost $3,000. While the exact reduction varies by lender and loan type, one discount point generally lowers the interest rate by approximately 0.25%. This upfront cost translates into a smaller monthly interest payment throughout the life of the loan.

Calculating Your Breakeven Point

A crucial step in evaluating whether to buy mortgage points involves calculating the breakeven point. This calculation determines how long it will take for the savings from a lower interest rate to offset the initial cost of the points. The breakeven point is found by dividing the total cost of the points by the monthly interest savings achieved. If the cumulative interest savings exceed the upfront cost, buying points can be financially advantageous.

To illustrate, consider a $250,000, 30-year fixed-rate mortgage at an initial interest rate of 7.0%. If a borrower pays two discount points, costing $5,000 (2% of $250,000), the interest rate might drop to 6.5%. This reduction could lower the monthly principal and interest payment by approximately $84. To find the breakeven point, divide the $5,000 cost of points by the $84 monthly savings, which equals roughly 60 months, or five years. This means it would take five years for the monthly savings to recover the initial investment.

Key Considerations for Your Decision

Beyond the mathematical breakeven point, several personal and market factors influence the decision to buy mortgage points. A primary consideration is the planned ownership period for the home. If a borrower intends to sell or refinance the mortgage before reaching the breakeven point, the upfront cost of points may not be recouped. Conversely, a longer tenure allows more time for the cumulative savings to surpass the initial expense, making points more beneficial.

The availability of cash and its opportunity cost are also significant. Paying for points requires a substantial upfront outlay at closing, which could otherwise be used for other financial priorities. This cash might be better allocated to an emergency fund, paying down higher-interest debt, or making a larger down payment to avoid private mortgage insurance (PMI). The decision should weigh the savings from a lower interest rate against potential returns from alternative investments.

The prevailing interest rate environment plays a role. In periods of high interest rates, buying points can significantly reduce monthly payments, making homeownership more affordable. However, in a low-interest-rate environment, the relative savings from points might be less substantial. The type of loan term, such as a 15-year versus a 30-year mortgage, can also impact the benefit. While a 15-year mortgage typically has a lower interest rate and faster equity build-up, a 30-year mortgage offers lower monthly payments, potentially making the savings from points more impactful on a stretched budget.

Understanding the tax implications is important, as discount points may be tax-deductible. Generally, points paid on a mortgage for a primary residence can be fully deducted in the year they are paid, provided certain IRS criteria are met, such as being a percentage of the loan amount and an established business practice. This deduction is claimed on Schedule A (Form 1040) as an itemized deduction. If the mortgage exceeds $750,000, limitations on the deductible amount may apply, and points paid on refinanced loans are typically deducted over the life of the loan. Consulting a tax professional is advisable to understand specific deductibility.