Mortgage Points: How They Work and When They Save You Money

What Are Mortgage Points?

Mortgage points are fees you pay to your lender at closing in exchange for a lower interest rate on your home loan. One point equals 1% of your principal loan amount.

Points are a form of prepaid interest. By paying more upfront, you reduce your monthly mortgage payment for the life of the loan. The decision to buy points hinges on how long you plan to keep the mortgage and whether the long-term savings outweigh the initial cost.

• Discount points: These are the points that lower your interest rate. Each point typically reduces the rate by about 0.25 percentage points, though the exact reduction varies by lender and market conditions.
• Origination points: These are fees charged by the lender for processing the loan. They do not reduce your interest rate.
• Points are listed on your Loan Estimate and Closing Disclosure on page 2, Section A, so you can see exactly what you are paying.

Sources: Federal Reserve Board, Consumer Financial Protection Bureau, Bankrate, Bank of America, Bank of Hawaii

Discount Points vs. Origination Points

It is easy to confuse the two types of points, but they serve very different purposes. Discount points are voluntary: you choose to pay them to lower your interest rate. Origination points, on the other hand, are fees the lender charges to originate (process) the loan. They do not affect your rate.

When you see points in a mortgage quote, ask your lender to clarify whether they are discount points, origination points, or both. This distinction matters because only discount points change your monthly payment.

• Discount points: Reduce your interest rate; each point typically lowers the rate by about 0.25%.
• Origination points: Cover lender processing costs; no rate reduction.
• Both types of points are paid at closing and are part of your closing costs.

Sources: Federal Reserve Board, Consumer Financial Protection Bureau, Bankrate, COPFCU, Bank of Hawaii, Investopedia

How Points Lower Your Interest Rate

When you buy discount points, you are essentially prepaying interest to the lender. In return, the lender reduces your mortgage interest rate. The exact rate reduction per point varies, but a common benchmark is about 0.25 percentage points per point.

The relationship between points and rate is not standardized, so you will need to get a quote from your lender to see the specific reduction they offer. Comparing loan estimates can help you see the trade-off between upfront costs and monthly savings.

• One point costs 1% of the loan amount.
• Typical rate reduction per point: about 0.25 percentage points, but varies by lender and loan type.
• Points are listed on your Loan Estimate and Closing Disclosure on page 2, Section A.

Sources: Consumer Financial Protection Bureau, Bankrate, COPFCU, Bank of America, Bank of Hawaii

How to Calculate the Break-Even Point

The break-even point is when your monthly savings from a lower interest rate equal the upfront cost of the points. To calculate it, follow these steps:

Step 1: Determine your loan amount and calculate the cost of points.

Step 2: Ask your lender for the interest rate with and without points.

Step 3: Calculate your monthly principal and interest payment for each scenario.

Step 4: Divide the cost of points by the monthly savings. So it would take about 5 years and 3 months to break even.

Now consider whether that makes sense for you. If you plan to live in the home for more than 5 years, buying the point will save you money in the long run. If you plan to move or refinance within 3 years, you would not reach the break-even point, so buying points may not be worth it.

You can use this method with your own numbers. Because the exact rate reduction varies by lender, you will need to request specific quotes to get a precise break-even calculation.

Sources: Consumer Financial Protection Bureau, Bankrate, COPFCU, Bank of Hawaii, U.S. Bank

When Does Paying Points Make Sense?

Paying points is generally a good idea if you plan to keep the mortgage long enough to pass the break-even point. The longer you keep the loan, the more you save. If you expect to move or refinance before you break even, buying points may not be the best use of your money.

Consider your cash flow and other financial goals. Paying points requires a larger upfront payment at closing. If you have limited savings for closing costs, you might prefer to keep that cash for emergencies or other expenses.

There is no one-size-fits-all answer. It depends on your timeline, the exact terms offered by your lender, and your personal financial situation.

• Paying points can be financially beneficial if you plan to keep the mortgage past the break-even point.
• If you might move or refinance soon, points may not pay off.
• Points are voluntary, so you always have the option to decline them.

Sources: Consumer Financial Protection Bureau, Bankrate, COPFCU, Bank of Hawaii, U.S. Bank

Are Mortgage Points Tax-Deductible?

Mortgage points may be tax-deductible as mortgage interest, but the rules depend on your individual situation and IRS guidance. Some sources note that points on a primary mortgage may be deductible in the year you pay them, while points on a refinance may need to be deducted over the life of the loan.

Because tax laws can change and individual circumstances vary, it is wise to consult a tax professional to determine whether you can deduct points and how to claim them.

• Points may be tax-deductible as mortgage interest, subject to IRS rules.
• Points on refinanced loans may not be fully deductible in the year paid.
• Consult a tax advisor for personalized guidance.

Sources: Federal Reserve Board, Bank of Hawaii, Investopedia

Factoring Points into Your APR

Your annual percentage rate (APR) includes the interest rate plus certain fees and costs, such as points. That is why a loan with points may have a higher APR than the advertised interest rate, even though the interest rate is lower.

When comparing mortgage offers, look at both the interest rate and the APR. The APR gives you a fuller picture of the true cost of the loan, including points and other upfront charges. However, the APR is not the same as your interest rate; your monthly payment is based on the nominal interest rate, not the APR.

• APR includes points and other closing costs, so it reflects the total cost of borrowing.
• The interest rate determines your monthly payment, while the APR provides a broader cost comparison.
• Compare both figures when evaluating loan offers.

Sources: Consumer Financial Protection Bureau, Bankrate, Bank of Hawaii