When you compare mortgage offers, you will often see a lower interest rate paired with a line item called discount points. Lenders give you a choice: pay more money upfront at closing, and in return receive a lower rate for the life of the loan. For some borrowers this is one of the smartest moves they can make. For others it is money they never get back. The difference comes down to how long you keep the loan and what else you could do with that cash.
What a mortgage point is
One discount point usually costs 1 percent of your loan amount. On a $350,000 mortgage, one point costs $3,500. In exchange, the lender lowers your interest rate, often by around 0.25 percentage points per point, though the exact reduction varies by lender and market conditions. You can typically buy fractions of a point, and some lenders allow up to three or four points. Points are separate from origination fees, which are charges for processing the loan and do not lower your rate.
Lenders sometimes offer the opposite as well, known as lender credits or negative points. You accept a slightly higher interest rate, and the lender pays part of your closing costs. This can be helpful if you are short on cash at closing or expect to sell or refinance within a few years. Looking at points and credits together gives you a full menu of rate and cost combinations to choose from.
Finding your break-even point
The most important calculation is the break-even point. Divide the cost of the points by the amount you save on your monthly payment. Suppose buying one point for $3,500 lowers your monthly principal and interest payment by $58. Dividing $3,500 by $58 gives you about 60 months, or five years. If you keep the loan longer than five years, the points save you money. If you sell the home or refinance before then, you would have been better off keeping the cash.
Be honest with yourself about how long you are likely to keep the mortgage. Many homeowners move or refinance well before their 30-year loan is paid off. If interest rates fall in the next few years and you refinance, the points you paid on the original loan are effectively lost. On the other hand, if you are buying a long-term family home and rates are already relatively low, points can produce meaningful savings over decades.
Taxes and other considerations
Discount points paid on a loan to buy your primary home may be tax deductible in the year you pay them if you itemize deductions and meet IRS requirements. Points paid on a refinance are usually deducted gradually over the life of the loan instead. Since most households now take the standard deduction, the tax benefit may be smaller than you expect, so it is worth confirming with a tax professional before you count on it.
When points may not make sense
Paying points ties up cash that could serve other important purposes. If buying points would leave you with a thin emergency fund, prevent you from making a larger down payment that avoids private mortgage insurance, or keep you from paying off high-interest debt, those uses usually come first. A larger down payment, for example, lowers both your loan balance and possibly your insurance costs, which can be a better return than a small rate reduction.
Making the decision with confidence
Ask each lender for a Loan Estimate that shows the rate with zero points as well as with one or two points, so you can compare like for like. Then calculate the break-even period for each option and weigh it against your plans for the home and your other financial goals. If you would like a second opinion, the Cash Fund Orbits mortgage team can line up your offers side by side and show you exactly when points start paying for themselves.
