Mortgage Points, When Buying Down the Rate Pays Off
When a lender offers you a lower rate "with points," you are being offered a trade: pay more cash now, pay less interest every month afterward. Whether that trade is a good one comes down to a single question: will you keep the loan long enough for the monthly savings to repay the upfront cost?
1. What a point is
The Consumer Financial Protection Bureau explains that one point equals one percent of the loan amount. On a $100,000 loan, one point is $1,000. Points do not have to be whole numbers; the CFPB gives examples of 1.375 points ($1,375), 0.5 points ($500), and 0.125 points ($125). Points are paid at closing and added to your closing costs.
By law, points listed on your Loan Estimate and Closing Disclosure, on page 2 in Section A, must be connected to a discounted interest rate. How much the rate drops for each point depends on the lender, the kind of loan, and the market. Sometimes the reduction per point is relatively large; sometimes it is small.
Lender credits are the same idea in reverse. You accept a higher rate and the lender gives you money toward closing costs. They appear as a negative number on page 2, Section J.
2. The CFPB's example
The CFPB uses a $180,000, 30-year fixed loan at 5.0% with zero points. In one option, you pay $675 more in closing costs for a rate of 4.875% and pay about $14 less each month. In the other, you accept 5.125% in exchange for $675 toward closing costs and pay about $14 more each month.
Divide the cost by the monthly savings and you get the break-even point: $675 / $14 is about 48 months. Keep the loan longer than four years and the points start paying you back. Sell or refinance sooner and you paid more than you saved.
3. A second example with today's-style numbers
Assume a $320,000, 30-year fixed loan. These rates are illustrative, not quotes.
| Option | Upfront cost | Rate | Principal and interest |
|---|---|---|---|
| No points | $0 | 6.50% | $2,022.62 |
| 1 point | $3,200 | 6.25% | $1,970.30 |
The monthly difference is about $52.32. The break-even is $3,200 / $52.32, or roughly 61 months, a little over five years.
| If you keep the loan for | Payment savings | Minus the $3,200 | Net result |
|---|---|---|---|
| 5 years (60 months) | $3,139 | -$3,200 | About -$61 |
| 10 years (120 months) | $6,279 | -$3,200 | About +$3,079 |
This simple comparison ignores what the $3,200 could have earned elsewhere and any tax effects, but it shows the shape: points reward time.
4. How to decide
The CFPB's advice is practical. If you do not know how long you will stay in the home or when you might refinance, and you have enough cash for closing and savings, you might not want to pay points or take lender credits at all. If you are unsure, ask the loan officer to show you options with and without points or credits, and to calculate the total cost over the shortest, longest, and most likely amount of time you expect to keep the loan.
Two more cautions from the CFPB:
- Some lenders use "points" loosely for any upfront fee calculated as a percentage of the loan, whether or not it lowers your rate. Ask exactly what the rate impact is.
- When comparing lenders, ask each for the same number of points or credits so the quotes are comparable.
5. The tax angle
The IRS describes points as a form of prepaid interest. If you itemize deductions, points that meet certain criteria may be deductible as home mortgage interest. For points on a loan to buy your main home to be deductible in the year paid, the IRS lists conditions that include: the loan is secured by your main home; paying points is an established business practice in your area and the amount is not more than generally charged there; you provide funds at or before closing at least equal to the points, not borrowed from the lender or broker; the points are computed as a percentage of the principal; and they show clearly as points on your settlement statement. Points on a refinance or a second home are generally deducted over the life of the loan instead.
Points charged in place of other costs, such as appraisal or title fees, are not deductible as interest. Because the deduction only helps if you itemize, check your own situation before counting on it.
6. Key takeaways
- One point is 1% of the loan amount, paid at closing, in exchange for a lower rate.
- Break-even month = cost of points / monthly payment savings; the CFPB's example breaks even in about 48 months.
- On a $320,000 loan, paying $3,200 to go from 6.50% to 6.25% saves about $52 a month and breaks even in about 61 months.
- If you might sell or refinance within a few years, points may not pay off.
- Points on a home purchase can be deductible if you itemize and meet the IRS conditions in Topic 504.