When Does It Make Sense to Buy Points on a Mortgage?

When considering a mortgage, prospective homeowners encounter various terms that influence the overall cost of their loan. One such term is “mortgage points,” which can potentially lower the interest rate. Understanding their financial implications is important for making an informed decision. This article clarifies what mortgage points are and guides you through the financial considerations involved in deciding whether buying them aligns with your goals.

What Are Mortgage Points

Mortgage points are fees paid directly to a lender at closing in exchange for a reduced interest rate on a home loan. This practice is often called “buying down the rate” or a “buydown.” Each mortgage point typically equals 1% of the total loan amount. For example, on a $300,000 mortgage, one point would cost $3,000.

There are two main types of mortgage points: discount points and origination points. Discount points are prepaid interest, paid upfront to lower the interest rate over the life of the loan. Each discount point generally reduces the interest rate by approximately 0.25%, though this reduction can vary by lender and loan product.

Origination points are fees paid to the lender for processing and underwriting the loan. These points cover administrative costs and do not directly reduce the interest rate. Unlike discount points, origination points are not tax-deductible. Discount points may be deductible as prepaid interest on tax returns for loans up to $750,000; consulting a tax professional is advisable. Both types of points are included as part of the closing costs.

How to Calculate Your Break-Even Point

The “break-even point” is a key calculation to determine if buying mortgage points is financially beneficial. This point represents the time it takes for savings from a lower interest rate to offset the upfront cost of the points. To calculate this, divide the total cost of the points by the monthly interest savings.

For example, on a $350,000 mortgage, a 7.0% rate results in a monthly payment of approximately $2,328. If you purchase one discount point, costing $3,500 (1% of $350,000), the interest rate might decrease to 6.75%. This could reduce your monthly payment to approximately $2,274.

The monthly savings would be $54 ($2,328 – $2,274). Dividing the point cost ($3,500) by the monthly savings ($54) yields approximately 64.8 months, or about 5.4 years. This means you need to keep the mortgage for at least 5.4 years to recoup the initial $3,500. If you maintain the mortgage beyond this period, every subsequent monthly payment results in net savings, making the purchase of points advantageous long term.

Key Considerations Beyond the Math

While the break-even calculation provides a clear financial roadmap, other practical factors influence the decision to buy mortgage points. Your anticipated loan tenure is a significant consideration. If you plan to sell the home or refinance before reaching the break-even point, the upfront cost of points may not be recovered, meaning you would lose money. Conversely, remaining in the home past the break-even period can lead to substantial savings over the life of the loan.

Your cash availability at closing is another important factor. Buying points adds to your closing costs, which typically range from 2% to 6% of the loan amount. Ensure paying for points does not deplete your cash reserves, potentially compromising your emergency fund or ability to cover other initial homeownership expenses. Lenders may require borrowers to maintain cash reserves, often several months’ worth of mortgage payments, even after closing. These reserves act as a financial cushion.

The prevailing interest rate environment also warrants consideration. If current interest rates are high, buying points might be more appealing as it offers a way to secure a lower rate and reduce monthly payments. However, if rates are volatile or expected to decline significantly, consider waiting or opting for a mortgage without points, especially if you anticipate refinancing soon. Ultimately, the decision balances upfront cost against long-term savings, tailored to your financial situation and housing plans.