Mortgage Points

The plain answer

Mortgage discount points are upfront fees you pay to get a lower interest rate. They can save money if you keep the loan long enough for the monthly savings to recover the fee. If you sell or refinance before that breakeven point, paying points may cost more than it saves.

How it actually works

One discount point generally costs one percent of the loan amount, but the rate reduction it buys is not fixed. It depends on the lender, loan, market, and day you lock the rate. A rate lock is the lender’s commitment to hold specified loan terms for a stated period, subject to its conditions.

Do not assume every fee labeled as a point lowers the rate. An origination point is a lender charge for making the loan, while a discount point is tied to a lower rate. Read the loan estimate to see how each charge is described and what rate applies.

The breakeven period is the time needed for monthly payment savings to equal the upfront cost of the points. Divide the cost of the points by the monthly principal-and-interest savings. That gives a rough number of months, but it does not include the return that cash could have earned elsewhere.

The annual percentage rate includes the interest rate and certain borrowing costs in a standardized measure. It can help compare offers, but it assumes a particular repayment pattern. Your actual result depends on how long you keep the mortgage and whether you pay it off early.

The reverse tradeoff is a lender credit. You accept a higher interest rate in exchange for the lender covering some upfront costs. This can preserve cash, but the higher payment continues for as long as you keep the loan.

What this means for you

Ask each lender for several versions of the same loan, such as one with points, one without them, and one with a lender credit. Keep the loan amount, term, and lock period the same. Then compare the upfront cost, monthly principal and interest, annual percentage rate, and total cost over the time you expect to keep the loan.

Paying points costs you cash and flexibility, so start with your likely holding period. Include the chance that you may move, refinance, or pay the loan off early. If that timeline is uncertain or paying points would weaken your cash reserve, the lower upfront cost may be more useful.

If you expect to keep the mortgage beyond the breakeven period and have ample cash after closing, points may reduce your cost. Use the actual quote rather than a rule of thumb because the price of a rate reduction changes.

Also compare points with a larger down payment. Both require cash upfront, but they change the loan in different ways. Ask the lender to show each scenario so you can see which produces the better combination of payment, interest, and remaining reserves.

Common mistakes

Do not buy points because a lower rate looks better by itself. A lower rate paired with a large fee may be worse over your expected timeline. Calculate the breakeven period first.

Do not compare one lender’s rate with another lender’s rate without matching the points and credits. A quote can advertise a low rate that requires more cash upfront. Compare complete offers gathered close together.

Another mistake is using all available closing cash to lower the rate. Points can reduce a payment, but they cannot pay for a repair or income interruption. Protect your emergency fund before prepaying interest.

Related pages

• Mortgage basics
• Down payments
• Refinancing
• Understanding interest rates