Is it better to pay points for a lower mortgage rate?

Should I pay for mortgage discount points?

Paying discount points to get a lower interest rate can be a great strategy. Lowering your rate even just 25 basis points (0.25%) could save you tens of thousands over the life of the loan.

But there’s a catch. You have to keep your mortgage long enough for the monthly savings to cancel out the cost of buying points.

Luckily, the math is simple; you can find out if points are worth it in just a few minutes. At today’s low rates, there are great deals to be had with or without discount points.

In this article (Skip to...)

• How points work
• Pros and cons
• When points are worth it
• When points aren’t worth it
• Should you buy points?

How do mortgage points work?

Discount points or ‘mortgage points’ let you pay extra upfront to lower your mortgage interest rate. Each point typically costs 1 percent of your loan amount and lowers your rate by about 0.25%.

For example:

• Loan amount: $250,000
• Original interest rate: 3.50%
• Cost of one discount point: $2,500 paid at closing
• New interest rate*: 3.25%

*Interest rates are for sample purposes only. Your own mortgage rate will vary.

Mortgage discount points are equivalent to prepaid interest. Instead of paying that interest in small amounts with each monthly mortgage payment, you can pay a chunk of it upfront to reduce the total amount due.

“Paying points upfront usually lowers your mortgage rate, which in turn lowers your mortgage payment,” explains Katsiaryna Bardos, chair and associate professor of the Finance Department at Fairfield University.

How much does a discount point lower my rate?

Typically, one point lowers your interest rate by about a quarter of a percent. But that can vary by lender and situation.

The amount you can lower your interest rate will depend on:

• Your mortgage lender
• Your loan type
• Your loan term
• Your loan amount
• The number of points you purchase

“For example, say you borrow $200,000 at a fixed interest rate of 3.0%. If you pay $2,000 upfront for one discount point, you may be able to buy your rate down to 2.75%, or 25 basis points. That would drop your payment by nearly $27 per month,” notes Chuck Meier, senior vice president and mortgage sales director at Sunrise Banks.

“However,” he continues, “your breakeven point would be 75 months to recoup the cost of the point you purchased, which would take just over six years.”

In other words, buying mortgage discount points may or may not be worth it based on your financial situation and timeline.

Pros and cons of mortgage discount points

The advantages and disadvantages of purchasing mortgage discount points are pretty simple.

“The pros are that the borrower receives a lower payment and pays less interest over time,” Meier says. “The cons are that they have to put more money into the transaction upfront out-of-pocket, and if they don’t remain in the home for a certain time, the cost is more than the benefit received.”

That might seem straightforward. But it takes a little math to apply those rules to your own situation. Here’s what to consider.

What to consider before buying discount points

Robert Killinger, senior loan officer of Inside Sales at Mortgage Network, says there are several variables to consider when trying to choose whether or not to pay discount points.

1. “First, you need to find out how low the eligible interest rate can drop after points are applied
2. “Second, you want to know how much the points would increase the closing costs of your loan compared to your available budget
3. “Third, determine if the additional cost of the discount points makes sense long-term — how long it will take to recoup the costs of the points versus the overall interest savings,” he suggests.

If you are cash-strapped for a down payment, don’t have a lot of money in reserves, and are purchasing a starter home that you will likely sell within a few years, buying discount points probably is not the best idea.

Benefits of paying discount points

For some, though, discount points make a lot of sense.

“If you have extra cash and you plan on remaining in your home for at least 10 years, you may be a good candidate [to purchase discount points],” says Meier.

Another good prospect is a landlord purchasing an investment property they’ll hold onto for a long period and rent out to prospective tenants.

“In this scenario, you can use discount points to drive your long-term interest rate down. Your cheaper mortgage payment could then lead to a better cash flow when collecting monthly rent on your property,” Killinger explains.

On the other hand, if you are seeking to flip an investment property relatively quickly, you likely won’t recoup the cost of the points you paid.

Meier also points out that buying discount points could reduce the amount of tax-deductible interest you can claim. “If a borrower itemizes and writes off interest on their taxes, they will have more interest to write off by keeping a slightly higher rate and not purchasing discount points,” he says.

But not every homeowner itemizes their taxes, and you should discuss your situation with a tax professional.

When discount points are worth it

Katherine Alves, executive vice president of Homeowners First Mortgage, says you want to ensure that purchasing discount points will result in a financial advantage.

“To do so, you need to calculate the cost versus savings over time. This is done by comparing rates with no points to a loan with points and reviewing the overall annual savings in the monthly payment,” recommends Alves.

“Then, you need to decide if you are going to remain in your home or the current mortgage loan long enough to recoup the costs of your discount points,” she explains. This is known as the ‘break-even point.’

Take a look at an example.

Assume a borrower named Steve purchases a home and takes out a 30-year mortgage for $400,000. He’s offered a 3.25% fixed interest rate.

• If Steve purchased one discount point –— a $4,000 upfront cost — he would save about $108 on each monthly payment
• It would take Steve 37 months (just over 3 years) to reach his breakeven point and recoup the $4,000 he paid upfront

“If Steve held onto the loan over its full 30-year term, he would save around $35,000 overall in interest by purchasing that single discount point,” Killinger says.

Here, the assumption is that Steve will stay put in his home and not refinance or sell until more than three years have passed. In this case, paying for a discount would be well worth it.

When discount points are not worth it

Now, take the same scenario as above. But imagine Steve decides he needs to sell that home two years after buying a $4,000 discount point.

“After 24 months of being in that loan, Steve would have recouped less than $2,600 of his initial $4,000 investment. With such short-term plans for his property, Steve is better off not increasing the costs of his loan with discount points and is better suited to take the higher original interest rate,” says Killinger.

Bardos reminds us that one of the most important considerations for choosing a loan with points is the length of time you plan to remain in the home until refinancing or selling.

“The longer the horizon, the more advantageous it is to prepay interest through points,” Bardos says.

Consider, as well, that the cash required for points could often be better spent on paying off high-interest credit card or student loan debt, building an emergency fund, or investing in stocks, bonds, or other investment vehicles that can yield a higher rate of return.

“This is especially true in our current low interest rate environment, when rates even without points are at historically low levels,” Bardos says.

The bottom line: Is buying mortgage points a good idea?

In summary, whether or not you should buy discount points for a lower rate depends on:

• How long you plan to keep your mortgage loan
• How much upfront cash you can afford for discount points at closing
• How much your interest rate will be reduced by purchasing points

“The use of discount points can be a great strategy to implement when it comes to mortgage financing. However, there needs to be some analysis done to confirm whether the savings seen with a reduced interest rate will outweigh the cost of the discount points and how that factors into your long-term plans for the property in question,” cautions Killinger.

A final note: Be aware of discount points when comparing mortgage loan offers.

Some lenders will quote rates with points, and some without. And if you’re comparing rates with different point structures, it’s not a fair comparison of which lender is truly the cheapest.

So make sure your Loan Estimates all contain the same number of points before choosing a home loan.

Your loan officer can help your compare loan options with and without discount points to determine whether the extra cost is worth it.