Mortgage points, explained: when buying down your interest rate pays off, and when it doesn't

What mortgage points are

One point equals 1% of the loan amount. On a $300,000 loan, one point is $3,000, and half a point is $1,500. The Consumer Financial Protection Bureau puts the trade plainly: points lower your interest rate in exchange for paying more at closing. Lender credits are the same trade in reverse, where you accept a higher rate and the lender gives you money toward closing costs.

How much one point lowers the rate is not fixed. It depends on the lender, the loan program, and the market that day, and the relationship is not always a straight line. That is why you should ask for the same loan priced two or three ways rather than relying on a rule of thumb.

Discount points vs origination points

The word points gets used for two different things. Discount points are optional prepaid interest: you pay them to buy down the rate. Origination points, or an origination fee quoted as a percentage, are a charge for making the loan. They do not lower your rate. A loan can have one, both, or neither.

On the Loan Estimate both live on page 2 in Section A, Origination Charges. Discount points appear on their own line as a percentage of the loan amount with the word Points. Everything else in Section A, such as application, underwriting, or origination fees, is the lender's charge for doing the loan. When you compare lenders, compare the Section A total at the same interest rate. A low rate with two points and a slightly higher rate with none can be the same deal wearing different clothes.

Buying down the interest rate: the break-even math

The break-even point is the upfront cost divided by the monthly savings. Here is a worked example using round, hypothetical numbers. These are not Home State Bank's rates, and the rate reduction per point in your quote may be larger or smaller.

In this example one point costs $3,000 and saves about $49 a month, so it takes about 61 months, a little over five years, to earn the money back in payment savings. The lower rate also pays principal down slightly faster, which adds to the benefit over time. Sell or refinance in year three and you lost money on the points. Keep the loan ten years and you came out several thousand dollars ahead.

When mortgage points make sense, and when they don't

Points reward staying put. Many mortgages are paid off or refinanced long before the final payment, because people move, families grow, and rates change. Be honest about your own timeline. A buyer settling into a long-term home in Cary or Oshkosh is a better candidate than someone who expects a job transfer in three years.

There is also an opportunity cost. The $3,000 could be part of a larger down payment that removes or reduces mortgage insurance, a reserve for the furnace that fails in the first winter, or simply not taken from savings. If paying points would drain your cash cushion, skip them.

• Points tend to make sense when you expect to keep the loan well past the break-even date and have cash left over after closing
• They tend not to make sense when you may sell or refinance within a few years
• If you expect to refinance when rates fall, paying points on a loan you plan to replace rarely works out
• If you need help with closing costs instead, ask about lender credits, which are the reverse trade

Seller-paid points

A seller can agree to pay discount points for you as part of a negotiated concession. In a slower market or on a new-construction home, a seller may prefer funding a permanent rate buydown to cutting the price. Seller-paid points count toward interested party contribution limits. On a conventional loan for a primary residence, Fannie Mae caps those contributions at 3% of the price when the loan-to-value ratio is above 90%, 6% from 75.01% to 90%, and 9% at 75% or below. FHA allows up to 6% of the sales price.

When a seller is offering money, run all three uses side by side: a price reduction, closing cost help, or points. The best choice depends on how long you will keep the loan and how much cash you have.

Are mortgage points tax deductible?

Sometimes. The IRS treats points as prepaid interest, so they are only useful to taxpayers who itemize deductions on Schedule A. Under IRS Topic 504 and Publication 936, points on a loan to buy or build your main home can generally be deducted in full in the year paid if a list of tests is met. Among them: the loan is secured by your main home, paying points is an established practice in your area and the amount is not more than is generally charged, the points are computed as a percentage of the loan amount and shown clearly on the settlement statement, and you brought at least that much of your own unborrowed money to closing.

Points paid on a refinance, or on a second home, are generally deducted ratably over the life of the loan rather than all at once. Seller-paid points can be treated as paid by the buyer, but you must reduce your basis in the home by the same amount. The IRS also says points charged in place of specific services, such as appraisal, inspection, title, and attorney fees, are not deductible as points.

Many homeowners take the standard deduction and get no tax benefit from points at all. We are lenders, not tax advisors, so confirm your own situation with a tax professional before counting a deduction in your break-even math.